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CAMBRIDGE  ECONOMIC  HANDBOOKS.— I 

GENERAL  EDITOR:   J.  M,    KEYNES,   M.A.,   C.B. 


SUPPLY  AND  DEMAND 


SUPPLY    AND 
DEMAND 


BY 


HUBERT  D.  IJENDERSON 

M.A. 

FELLOW   OP  CLARE  COLLEGE,    CAMBRIDGE 
LECTURER  IN  ECONOMICS  IN  THE  UNIVERSITY   OF  CAMBRIDGE 


WITH  AN  INTRODUCTION  BY 

J.  M.  KEYNES 

M.A.,   C.B. 
FELLOW  OF  kino's  COLLEGE,  CAMBRIDGE 


NEW  YORK 
HARCOURT,  BRACE  AND  COMPANY 


COPYRIGHT,  1922,  BY 
HAECOURT,  BRACE  AND  COMPANY,  INC. 


Printed  in  the  U.  S.  A. 


INTRODUCTION 

The  Theory  of  Economics  does  not  furnish  a  body 
of  settled  conclusions  immediately  applicable  to  policy. 
It  is  a  method  rather  than  a  doctrine,  an  apparatus  of 
the  mind,  a  technique  of  thinking,  which  helps  its 
possessor  to  draw  correct  conclusions.  It  is  not  difficult 
in  the  sense  in  which  mathematical  and  scientific 
techniques  are  difficult;  but  the  fact  that  its  modes  of 
expression  are  much  less  precise  than  these,  renders 
decidedly  difficult  the  task  of  convejdng  it  correctly  to 
the  minds  of  learners. 

Before  Adam  Smith  this  apparatus  of  thought 
scarcely  existed.  Between  his  time  and  this  it  has  been 
steadily  enlarged  and  improved.  Nor  is  there  any 
branch  of  knowledge  in  the  formation  of  which  English- 
men can  claim  a  more  predominant  part.  It  is  not 
complete  yet,  but  important  improvements  in  its 
elements  are  becoming  rare.  The  main  task  of  the 
professional  economist  now  consists,  either  in  obtaining 
a  wide  knowledge  of  relevant  facts  and  exercising  skill 
in  the  application  of  economic  principles  to  them,  or  in 
expounding  the  elements  of  his  method  in  a  lucid, 
accurate  and  illuminating  way,  so  that,  through  his 
instruction,  the  number  of  those  who  can  think  for 
themselves  may  be  increased. 

This  Series  is  directed  towards  the  latter  aim.  It 
is  intended  to  convey  to  the  ordinary  reader  and  to  the 
uninitiated  student  some  conception  of  the  general 


vi  INTRODUCTION 

principles  of  thought  which  economists  now  apply  to 
economic  problems.  The  writers  are  not  concerned  to 
make  original  contributions  to  knowledge,  or  even  to 
attempt  a  complete  summary  of  all  the  principles  of  the 
subject.  They  have  been  more  anxious  to  avoid  ob- 
scure forms  of  expression  than  difficult  ideas;  and  their 
object  has  been  to  expound  to  intelligent  readers, 
previously  unfamiliar  with  the  subject,  the  most  sig- 
nificant elements  of  economic  method.  Most  of  the 
omissions  of  matter  often  treated  in  textbooks  are 
intentional;  for  as  a  subject  develops,  it  is  important, 
especially  in  books  meant  to  be  introductory,  to  discard 
the  marks  of  the  chrysalid  stage  before  thought  had 
wings. 

Even  on  matters  of  principle  there  is  not  yet  a 
complete  unanimity  of  opinion  amongst  professors. 
Generally  speaking,  the  writers  of  these  volumes  be- 
lieve themselves  to  be  orthodox  members  of  the  Cam- 
bridge School  of  Economics.  At  any  rate,  most  of 
their  ideas  about  the  subject,  and  even  their  prejudices, 
are  traceable  to  the  contact  they  have  enjoyed  with  the 
writings  and  lectures  of  the  two  economists  who  have 
chiefly  influenced  Cambridge  thought  for  the  past  fifty 
years,  Dr.  Marshall  and  Professor  Pigou. 

J.  M.  Keynes. 


CONTENTS 

CHAPTER   I 
THE  ECONOMIC  WORLD 


PAGE 
1 


§  1.  Theory  and  Fact 

§  2.  The  Division  op  Labor          .....  3 

§  3.  The  Existence  of  Order       .....  5 

§  4.  Some  Reflections  upon  Joint  Products         .         .  7 

§  5.  Some  Reflections  upon  Capital  .         .         .11 

§  6.  The  Fundamental  Character  of  many  Economic 

Laws 17 

CHAPTER  II 

THE  GENERAL  LAWS  OF  SUPPLY  AND  DEMAND 

§  1.  Preliminary  Statement  op  Three  Laws  .  .  18 
§  2.  Diagrams  and  their  Uses  .  .  .  .21 
§3.    Ambiguities  op  the   Expressions,    "Increase  in 

Demand,"  etc.   .......  24 

§  4.    Reactions  op  Changes  in  Demand  and  Supply  on 

Price 27 

§  5.    Some  Paradoxical  Reactions  of  Price  Changes  on 

Supply 30 

§  6.    The  Disturbances  op  Monetary  Changes     .         .  33 

§7.     The  Trade  Cycle 34 

CHAPTER  HI 

UTILITY  AND  THE  MARGIN  OF  CONSUMPTION 

§  1.    The  Forces  behind  Supply  and  Demand  .     37 

§  2.    The  Law  of  Diminishing  Utility  .         .         .40 

vii 


viii  CONTENTS 

PAGE 

§  3.    The    Relation    Between    Price    and    Marginal 

Utility      ........     43 

§  4.     The  Marginal  Purchaser     .         .         .         .         .44 

§  5.     The  Business  Man  as  Purchaser  .         .         .47 

§  6.    The  Diminishing  Utility  of  Money       .         .         .49 

CHAPTER  IV 

COST  AND  THE  MARGIN  OF  PRODUCTION 

§  1.  An  Illustration  from  Coal  .         .         .         .52 

§  2.  The  Various  Aspects  op  Marginal  Cost        .         ,     55 

§  3.  The  Dangers  op  Ignoring  the  Margin  .         .     57 

§  4.  A  Misinterpretation    .         .         .         .         .         .59 

§  5.  Some  Consequences  of  a  Higher  Price  Level        .     60 

§  6.  General  Relation  Between  Price,  Utility  and 

Cost  ........     65 

CHAPTER  V 

JOINT  DEMAND  AND  SUPPLY 

§  1.  Marginal  Cost  under  Joint  Supply       .         .         .66 

§  2.  Marginal  Utility  under  Joint  Demand         .  .     69 

§  3.  A  Contrast  Between  Cotton  and  Cotton-seed,  and 

Wool  and  Mutton     ......     71 

§  4.  The  Importance  op  being  Unimportant  .         .     74 

§  5.  Capital  and  Labor        .  .         .  .  .  .76 

§  6.  Conclusions  as  to  Joint  Supply  and  Joint  Demand    79 

§  7.  Composite  Supply  and  Composite  Demand     .         .     79 

§  8.  Ultimate  Real  Costs  .         .         .         ,         .82 

CHAPTER  VI 

LAND 

§  1.    The  Special  Characteristics  op  Land  ,         .         .83 
§  2.     The  Scarcity  Aspect     ......     84 


CONTENTS 


IX 


PAGE 

§  3.  The  Differential  Aspect      .          .         .         .         .87 

§  4.  The  Margin  of  Transference       .         .         .         .94 

§  5.  The  Necessity  of  Rent          .         .         .         .         .98 

§  6.  The  Question  op  Real  Costs         ....  100 

§  7.  Rent  and  Selling  Price        .....  102 

CHAPTER  VII 

RISK-BEARING  AND  ENTERPRISE 

§  1.  Profits  and  Earnings  op  Management  .         .   104 

§  2.  The  Payment  for  Risk-bearing     ....   104 

§  3.  Monte  Carlo  and  Insurance         ....   105 

§  4.  Risk  under  Large  Scale  Organization  .         .  Ill 

§  5.  The  Entrepreneur        .  .  .         .         .         .113 

§  6.  Risk-taking  and  Control      .....   116 

§  7.  General  Analysis  of  Profits         ....  117 

CHAPTER   VIII 

CAPITAL 

§  1.     A  Reference  to  Marx  .....  119 

§  2.     Waiting  for  Production        .....  120 

§  3.     Waiting  for  Consumption     .....  121 

§  4.     Capital  not  a  Stock  of  Consumable  Goods  .         .  123 

§  5.     The  Essence  op  Waiting       .....  126 

§  6.     Individual  and  Social  Saving         ....  127 

§  7.     The  Necessity  of  Interest  .....  129 

§  8.     The  Supply  of  Capital  .....  130 

§  9.     Involuntary  Saving      ......  134 

§  10.  Interest  and  Distribution    .....  137 

CHAPTER   IX 

LABOR 

§  1.     A  Retrospect  on  Laissez-faire      ....   139 
§  2.     Ideas  and  Institutions  .....   141 


X  CONTENTS 

PAGE 

§  3.    The  General.  Wage-level     .....  143 

§  4.     The  Supply  of  Labor  in  General  ....  145 

§  5.     The  Apportionment  of  Labor  among  Places  .         .  147 
§  6.     The    Apportionment    of     Labor    among    Social 

Grades      ........  149 

§  7.     The  Apportionment  of  Labor  among  Occupations  153 

§8.     Women's  Wages 157 

CHAPTER  X 

THE  REAL  COSTS  OF  PRODUCTION 

§  1.     Comparative  Costs        ......  162 

§  2.     The  Allocation  of  Resources       ....  166 

§  3.     Utility  and  Wealth      ......  170 

§  4.    Criteria  of  Policy 172 


SUPPLY  AND  DEMAND 

CHAPTER  I 

THE  ECONOMIC  WORLD 

§  1.  Theory  and  Fact.  The  controversy  between  the 
"Theorist"  and  the  "Practical  Man"  is  common  to 
all  branches  of  human  affairs,  but  it  is  more  than  usually 
prevalent,  and  perhaps  more  than  usually  acrid  in  the 
economic  sphere.  It  is  always  a  rather  foolish  contro- 
versy, and  I  have  no  intention  of  entering  into  it,  but 
its  prevalence  makes  it  desirable  to  emphasize  a  plati- 
tude. Economic  theory  must  be  based  upon  actual 
fact:  indeed,  it  must  be  essentially  an  attempt,  like  all 
theory,  to  describe  the  actual  facts  in  proper  sequence, 
and  in  true  perspective;  and  if  it  does  not  do  this  it  is 
an  imposture.  Moreover,  the  fafcts  which  economic 
theory  seeks  to  describe  are  primarily  economic  facts, 
facts,  that  is  to  say,  which  emerge  in,  and  are  concerned 
with,  the  ordinary  business  world;  and  it  is,  therefore, 
mainly  upon  such  facts  that  the  theory  must  be  based. 
People  sometimes  speak  as  though  they  supposed  the 
economist  to  start  from  a  few  psychological  assimiptions 
(e.  g.  that  a  man  is  actuated  mainly  by  his  own  self- 
interest)  and  to  build  up  his  theories  upon  such  founda- 
tions by  a  process  of  pure  reasoning.  When,  therefore, 
some  advance  in  the  study  of  psychology  throws  into 

1 


2  SUPPLY  AND  DEMAND 

apparent  disrepute  such  ancient  maxims  about  human 
nature,  these  people  are  disposed  to  conclude  that  the 
old  economic  theory  is  exploded,  since  its  psychological 
premises  have  been  shown  to  be  untrue.  Such  an 
attitude  involves  a  complete  misunderstanding  not 
merely  of  economics,  but  of  the  processes  of  human 
thought.  It  is  quite  true  that  the  various  branches  of 
knowledge  are  interrelated  very  intimately,  and  that 
an  advance  in  one  will  often  suggest  a  development  in 
another.  By  all  means  let  the  economist  and  psychol- 
ogist avoid  a  pedantic  specialism  and  let  each  stray 
into  the  other's  province  whenever  he  thinks  fit.  But 
the  fact  remains  that  they  are  primarily  concerned 
with  different  things:  and  that  each  is  most  to  be 
trusted  when  he  is  upon  his  own  ground.  When, 
therefore,  the  economist  indulges  in  a  generalization 
about  psychology,  even  when  he  gives  it  as  a  reason  for 
an  economic  proposition,  in  nine  cases  out  of  ten  the 
economics  will  not  depend  upon  the  psychology;  the 
psychology  will  rather  be  an  inference  (and  very 
possibly  a  crude  and  hasty  one)  from  the  economic 
facts  of  which  he  is  tolerably  sure. 

But  the  purpose  of  economic  theory  is  not  merely  to 
describe  the  facts  of  the  economic  world;  it  is  to  de- 
scribe them  in  their  proper  sequence  and  true  per- 
spective. It  must  begin  with  those  facts  which  are 
most  general  and  which  have  the  widest  possible 
significance.  Those  are  not  likely  to  be  the  facts 
which  our  practical  experience  forces  most  insistently 
upon  our  notice.  For  it  is  the  particular  and  not  the 
general,  the  differences  between  things  rather  than  their 
resemblances,  that  concern  us  most  in  daily  life.    Nor 


THE  ECONOMIC  WORLD  3 

are  we  likely  to  find  the  universal  facts  which  we 
require  in  the  sphere  of  public  controversy.  We  must 
rather  look  for  them  in  the  dark  recesses  of  our  con- 
sciousness, where  are  stored  those  truths  which  are  so 
obvious  that  we  hardly  notice  them,  which  are  so  indis- 
putable that  we  seldom  examine  them,  which  seem  so 
trite  that  we  are  apt  to  miss  their  full  significance. 

§  2.  The  Division  of  Labor.  There  is  one  such  truth 
in  the  economic  sphere  which  it  is  essential  to  appreciate 
vividly  and  fully,  with  the  widest  sweep  of  the  imagina- 
tion and  the  sharpest  clarity  of  thought.  Man  lives  by 
cooperating  with  his  fellow-men.  In  the  modern 
world,  that  cooperation  is  of  a  boundless  range  and  an 
indescribable  complexity.  Yet  it  is  essentially  un- 
designed and  uncontrolled  by  man.  The  humblest 
inhabitant  of  the  United  States  or  Great  Britain  de- 
pends for  the  satisfaction  of  his  simplest  needs  upon 
the  activities  of  innumerable  people,  in  every  walk  of 
life  and  in  every  corner  of  the  globe.  The  ordinary 
commodities  which  appear  upon  his  dinner  table 
represent  the  final  product  of  the  labors  of  a  medley  of 
merchants,  farmers,  seamen,  engineers,  workers  of 
almost  every  craft.  But  there  is  no  human  authority 
presiding  over  this  great  complex  of  labor,  organizing 
the  various  units,  and  directing  them  towards  the 
common  ends  which  they  subserve.  Wheel  upon 
wheel,  in  a  ceaseless  succession  of  interdependent 
processes,  the  business  world  revolves:  but  no  one  has 
planned  and  no  one  guides  the  intricate  mechanism 
whose  smooth  working  is  so  vital  to  us  all.  Man,  in- 
deed, can  organize  and  has  organized  much.    Within 


4  SUPPLY  AND  DEMAND 

a  large  factory  the  efforts  of  thousands  of  work-people, 
each  engaged  on  the  repetition  of  a  single  small  process, 
are  fitted  together  so  as  to  form  an  ordered  whole  by 
the  conscious  direction  of  the  management.  Some- 
times factory  is  joined  with  factory,  with  farms,  fish- 
eries, mines,  with  transport  and  distributing  agencies, 
as  one  gigantic  business  unit,  controlled  by  a  common 
will.  These  giant  businesses  are  remarkable  achieve- 
ments of  man's  organizing  gifts.  The  individuals  who 
control  them  wield  an  immense  power,  which  so  im- 
presses the  public  imagination  that  we  dub  them 
"kings,"  "supermen,"  "Napoleons  of  industry."  But 
how  small  a  portion  of  man's  economic  life  is  dominated 
by  such  men!  Even  as  regards  the  affairs  of  their  own 
businesses,  how  narrow,  after  all,  are  the  limits  of  their 
influence!  The  prices  at  which  they  can  buy  their 
materials  and  borrow  their  capital,  the  quantities  of 
their  products  which  the  public  will  consume,  are 
factors  at  once  vital  to  their  prosperity  and  outside 
their  own  control. 

A  great  business,  like  a  nation,  may  cherish  visions  of 
self-suflSciency,  may  stretch  its  tentacles  forward  to  the 
consumer  and  backwards  to  its  supplies  of  raw  mate- 
rial; but  each  fresh  extension  of  its  activities  serves  only 
to  multiply  its  points  of  contact  with  the  outside  world. 
When  those  points  are  reached,  the  largest  business, 
like  the  smallest,  is  out  on  the  open  sea  of  an  economic 
system  immeasurably  larger  and  more  powerful  than 
itself.  There  it  must  meet — the  better  perhaps  for  its 
inherent  strength  and  accumulated  knowledge — the 
impact  of  rude  forces,  which  it  is  powerless  to  control. 
Beneath  the  blasts  of  a  trade  depression,  or  some  other 


THE  ECONOMIC  WORLD  5 

tendency  of  world-wide  scope,  the  authority  of  the 
mightiest  industrial  magnate,  and  equally  of  any 
Government,  assumes  the  same  essential  insignificance 
as  the  pride  of  a  man  humbled  by  contact  with  the 
elemental  powers  of  nature. 

§  3.  The  Existence  of  Order.  The  parallel  can  be 
pursued  further  with  advantage.  Just  as  in  the  world 
of  natural  phenomena,  which  for  long  seemed  to  man  so 
wayward  and  inexplicable,  we  have  come  gradually 
to  perceive  an  all-pervading  uniformity  and  order;  so 
there  is  manifest  in  the  economic  world,  uniformity, 
order,  of  a  similar  if  less  majestic  kind.  Upon  the 
cooperation  of  his  fellowmen,  man  depends  for  the  very 
means  of  life :  yet  he  takes  this  cooperation  for  granted, 
with  a  complacent  confidence  and  often  with  a  naive 
unconsciousness,  as  he  takes  the  rising  of  to-morrow's 
sun.  The  reliability  of  this  unorganized  cooperation 
has  powerfully  impressed  the  imagination  of  many 
observers. 

"On  entering  Paris  which  I  had  come  to  visit," 
exclaimed  Bastiat  some  seventy  years  ago,  "I  said  to 
myself — Here  are  a  million  of  human  beings  who  would 
all  die  in  a  short  time  if  provisions  of  every  kind  ceased 
to  flow  towards  this  great  metropolis.  Imagination  is 
baffled  when  it  tries  to  appreciate  the  vast  multiplicity 
of  commodities  which  must  enter  to-morrow  through 
the  barriers  in  order  to  preserve  the  inhabitants  from 
falling  a  prey  to  the  convulsions  of  famine,  rebellion, 
and  pillage.  And  yet  all  sleep  at  this  moment,  and  their 
peaceful  slumbers  are  not  disturbed  for  a  single  instant 
by  the  prospect  of  such  a  frightful  catastrophe.    On 


6  SUPPLY  AND  DEMAND 

the  other  hand,  eighty  departments  have  been  laboring 
to-day,  without  concert,  without  any  mutual  under- 
standing, for  the  provisioning  of  Paris." 

The  theme  may  well  excite  wonder.  But  wonder 
should  always  be  watched  with  a  wary  eye;  for  he  is 
apt  to  bring  in  his  train  a  hanger-on  called  worship, 
who  can  do  nothing  but  mischief  here.  It  is  a  short  step 
from  a  passage  like  that  quoted  above  to  a  glorification 
of  the  existing  system  of  society,  to  a  defence  of  all 
manner  of  indefensible  things;  and  a  cross-grained 
attitude  towards  all  projects  of  reform.  It  is  a  short 
step;  but  it  is  one  which  it  is  quite  unjustifiable  to  take. 
For  the  evils  of  our  economic  system  are  too  plain  to  be 
ignored;  too  many  people  have  harsh  personal  experi- 
ence of  the  wastefulness  of  its  production,  the  injustice 
of  its  distribution;  of  its  sweating,  its  unemployment 
and  slums.  And  when  the  attempt  is  made  to  plaster 
over  evils  such  as  these  with  obsequious  rhetoric  about 
the  majesty  of  economic  law,  it  is  not  surprising  that  the 
spirit  of  many  men  should  revolt  and  that  they  should 
retort  by  denying  the  existence  of  order  in  the  business 
world,  by  declaring  that  the  spectacle  which  they  see  is 
one  of  discord,  confusion  and  chaos.  And  then  we  are 
engulfed  in  a  controversy  as  stale,  flat  and  unprofitable 
as  that  between  the  "theorist"  and  the  "practical 
man." 

The  truth  is  that  the  language  of  praise  and  obloquy 
is  quite  inappropriate.  In  the  first  place,  it  may  be  well 
to  note  that  the  order  of  which  I  have  spoken  manifests 
itself  not  merely  in  those  economic  phenomena  which 
are  beneficial  to  man,  but  hardly  less  in  those  which 
work  to  his  hurt.    Even  in  those  alternations  of  good 


THE  ECONOMIC  WORLD  7 

and  bad  trade,  which  spell  so  much  unemployment  and 
misery,  there  is  discernible  a  rhythmic  regularity  like 
that  of  the  process  of  the  seasons,  or  the  ebb  and  flow 
of  the  tide.  This  is  not  an  elegance  to  be  admired.  Fur- 
thermore, in  so  far  as  the  order  comprises  adjustments 
and  tendencies  which  are  beneficial  (as,  indeed,  is 
mainly  true),  there  is  no  warrant  for  assuming  that  these 
are  either  adequate  to  secure  a  prosperous  community 
or  dependent  upon  the  social  arrangements  which  hap- 
pen to  exist.  Let  us,  therefore,  refrain  from  premature 
polemics  and  examine  in  a  spirit  of  detachment  some 
further  aspects  of  the  elaborate,  but  yet  imorganized, 
cooperation  of  which  so  much  has  been  already  said. 

§  4.  Some  Reflections  upon  Joint  Products.  A  quite 
inadequate  idea  of  the  complexity  of  this  cooperation 
is  obtained  by  dwelling  on  the  numbers  of  people  who 
participate  in  it,  or  the  immense  distances  over  which  it 
extends.  The  deficiency  can  be  partially  supplied  by 
referring  to  some  of  the  more  obvious  of  the  many 
subtle  interconnections  which  exist  between  different 
commodities  and  different  trades. 

There  are  innumerable  groups  of  commodities  (which 
it  is  customary  to  term  "joint  products")  such  that  the 
production  of  one  commodity  belonging  to  the  group 
necessarily  implies  or  very  greatly  facilitates  the  pro- 
duction of  the  others.  Wool  and  mutton;  beef  and 
hides;  cotton  and  cotton-seed  are  a  few  familiar  illus- 
trations. The  important  feature  of  these  "joint  prod- 
ucts" is  the  fairly  precise  relation  which  must  exist 
between  the  quantities  in  which  the  different  products 
are  supplied.    If  you  plant  a  certain  crop  of  cotton,  it 


8  SUPPLY  AND  DEMAND 

will  yield  you  so  much  cotton  lint  and  so  much  cotton- 
seed. You  can,  of  course,  if  you  choose,  throw  away 
part  of  the  seed,  as  indeed  at  one  time  planters  used  to 
do;  but  unless  you  do  this,  you  cannot  vary  the  pro- 
portions of  the  two  things  which  you  will  have  for  sale. 
Similarly,  if  you  keep  a  flock  of  sheep,  or  a  herd  of  cattle, 
you  will  obtain  wool  and  mutton  in  the  one  case,  or  beef 
and  hides  in  the  other,  in  proportions,  which  indeed  you 
can  vary  within  certain  limits  by  choosing  a  different 
breed,^  but  which  you  cannot  radically  transform. 
When,  however,  we  turn  to  the  uses  to  which  these 
products  are  put,  no  similar  relation  is  to  be  discovered. 
Cotton  lint  is  used  chiefly  for  making  articles  of  cloth- 
ing; cotton-seed  for  crushing  into  oil,  on  the  one  hand, 
and  cake  for  cattle  fodder  on  the  other.  There  is  no 
apparent  connection  of  any  kind  between  the  demands 
for  these  different  things,  and  still  less  is  there  any 
obvious  reason  why  these  demands  should  bear  to  one 
another  the  particular  proportions  which  characterize 
their  respective  supplies.  It  is  very  much  the  same  with 
wool  and  mutton;  with  beef  and  hides;  with  all  "joint 
products."  Why  should  we  consume  mutton  on  the 
one  hand  and  woolen  clothing  on  the  other,  in  a  ratio 
at  all  commensurate  with  that  in  which  they  are 
yielded  by  the  sheep? 

What,  then,  might  we  expect  to  find  if  order  was  non- 
existent in  the  economic  world?  Surely  that  some 
things  such  as  wool  would  be  produced  in  quantities 
many  times  in  excess  of  the  demand  for  them,  quite 

1  These  possibilities  of  small  variation  are  of  very  great  impor- 
tance as  will  be  shown  in  Chapter  V,  but  they  do  not  affect  the 
present  argument. 


THE  ECONOMIC  WORLD  9 

possibly  five,  ten,  or  twenty  times  in  excess;  while 
conversely  the  suppUes  of  others  such  as  mutton  might 
fall  far  short  of  what  was  required.  But  in  practice  we 
find  nothing  of  the  sort.  Somehow  it  comes  about 
that  an  equilibrium  is  established  between  the  demand 
for  and  the  supply  of  every  commodity;  and  that  this 
applies  to  wool  and  mutton,  to  beef  and  hides,  as  surely 
as  to  commodities  which  are  produced  quite  independ- 
ently. It  is  true  that  this  equilibrium  is  a  rough, 
imperfect  one;  and  it  may  happen  that  what  is  called  a 
"glut"  of  wool  may  co-exist  for  a  short  period  with 
what  is  called  a  scarcity  of  mutton.  But  quaUfications 
of  this  nature  are  in  the  strictest  sense  of  the  phrase,  the 
exceptions  which  prove  the  rule.  For  the  departures 
from  equihbrium  which  gluts  and  scarcities  represent 
are  always  transient  and  are  usually  confined  within 
narrow  limits.  A  strong  prevailing  trend  towards  an 
adjustment  of  demand  and  supply  is  unmistakably 
manifest  amid  all  the  vagaries  of  changing  circumstance. 
Let  me  carry  the  argument  a  step  further  for  the 
benefit  of  any  reader  who  is  restrained  by  a  repugnance 
too  deep  and  instinctive  to  be  readily  overcome,  from 
admitting  fairly  to  his  mind  that  conception  of  order 
which  I  am  endeavoring  to  emphasize.  He  will  in  all 
probability  be  one  who,  cherishing  ideals  of  a  better  and 
fairer  system  of  society,  looks  forward  to  a  time  when  an 
organized  cooperation  will  be  substituted  for  what  he 
regards  as  the  existing  chaos.  Let  us  suppose  that  his 
visions  were  fulfilled  as  completely  as  he  could  desire; 
and  that  an  immense  system  of  Sociahsm  were  in  exist- 
ence, embracing  not  one  country  only,  but  the  whole 
world.    Suppose  all  the  difiiculties  of  human  perversity 


10  SUPPLY  AND  DEMAND 

and  administrative  technique  to  have  been  sunnounted 
and  a  wise,  disinterested  executive  to  be  in  supreme 
control  of  our  business  hfe.  Let  us  suppose  all  this,  and 
ask  only  the  question :  How  would  this  executive  treat 
the  humdrum  case  of  wool  and  mutton?  How  would 
it  decide  the  number  of  sheep  it  would  maintain? 

Shall  we  suppose  that  it  is  inspired  by  the  ideal  "to 
each  according  to  his  need,"  and  that  it  resolves  accord- 
ingly that  the  commodities  vv^hich  people  requhe  for  a 
decent  standard  of  life  shall  be  supphed  to  them  as  a 
matter  of  course?  How,  then,  would  it  proceed?  It 
might  estimate  the  amount  of  woolen  clothing  which  a 
normal  family  requires,  allowing  for  differences  in 
climate,  and  possibly  indulging  somewhat  the  caprices 
of  human  taste.  On  this  basis,  a  certain  number  of 
sheep  would  be  indicated.  It  might  perform  a  similar 
calculation  for  mutton,  and  again  a  certain  number  of 
sheep  would  be  indicated.  But  it  would  be  an  ex- 
traordinary coincidence  if  the  numbers  which  resulted 
from  these  independent  calculations  were  nearly  equal 
to  one  another,  or  were  even  of  the  same  order  of  mag- 
nitude; and,  if  they  differed  widely,  what  number  would 
our  world  executive  select?  Would  it  decide  to  waste 
an  immense  quantity  of  either  wool  or  mutton;  or 
would  it  decide  that  it  could  not,  after  all,  supply 
the  full  human  needs  for  one  or  other  of  the  com- 
modities? 

Of  course,  if  the  executive  were  sensible  it  could  solve 
the  problem  satisfactorily  enough.  It  could  retain  the 
monetary  system  we  know  to-day  and  it  could  supply 
the  commodities  to  the  consumers,  not  as  a  matter  of 
right,  but  by  selling  them  to  them  at  a  'price.    This  price 


THE  ECONOMIC  WORLD  11 

it  could  then  move  upwards  or  downwards,  raising,  say, 
the  price  of  mutton  and  reducing  that  of  wool,  until  it 
found  that  the  consumption  of  the  two  things  was 
adjusted  in  the  required  ratio.  But  if  it  acted  in  this 
manner,  what  essentially  would  it  be  doing?  It  would 
be  seeking  by  deliberate  contrivance  to  reproduce,  in 
respect  of  this  particular  problem,  the  very  conditions 
which  occur  to-day  without  aim  or  effort  on  the  part  of 
anyone  at  all. 

The  moral  of  this  illustration  must  not  be  misin- 
terpreted. It  does  not  show  the  folly  of  Socialism  or  the 
superiority  of  Laissez-faire.  What  it  does  show  is  the 
existence  in  the  economic  world  of  an  order  more 
profound  and  more  permanent  than  any  of  our  social 
schemes,  and  equally  applicable  to  them  all. 

§  5.  Some  Reflections  upon  Capital.  Another  aspect 
of  the  great  cooperation  is  of  even  greater  significance. 
It  embraces  not  only  a  multitude  of  living  men,  but  it 
links  the  present  together  with  the  future  and  the  past. 
The  goods  and  services  which  we  enjoy  to-day  we  owe 
only  in  part  to  the  labors  of  the  week,  the  month,  or 
the  year,  only  in  part  even  to  the  efforts  of  our  contem- 
poraries. The  men,  long  since  dead  and  forgotten,  who 
built  our  railways,  or  sunk  our  coal  mines,  or  engaged 
in  any  of  a  great  variety  of  tasks,  are  still  contributing 
to  the  satisfaction  of  our  daily  wants.  The  expression 
is  not  altogether  fanciful ;  for,  had  it  not  been  reasonable 
to  expect  that  those  labors  would  be  of  use  to  us  to-day, 
many  of  them  in  all  probability  would  never  have  been 
undertaken.  It  was  to  meet  our  present  wants,  and 
even  our  future  wants,  that  many  men  toiled  on  monot- 


12  SUPPLY  AND  DEMAND 

onous  tasks  ten,  twenty,  thirty  years  ago.  And  yet, 
of  course,  we  should  deceive  ourselves  if  we  supposed 
that  this  was  the  motive  of  these  men,  that  our  welfare 
was  the  centre  of  their  heart's  desire.  We  in  our  turn 
dedicate  to  the  future,  and  often  to  a  distant  future, 
an  immense  portion  of  our  energies.  Let  any  reader 
who  doubts  this,  study  the  statistics  of  the  occupations 
of  the  people,  and  reflect  on  how  long  a  period  must 
elapse  before  the  labors  of  this  trade  or  that  can  fulfil 
their  ultimate  function.  How  long  would  the  period  be 
in  the  case  of  a  man  making  bricks,  which  will  later  be 
employed  in  the  erection  of  a  factory,  where  machinery 
will  be  made,  to  equip  an  electrical  generating  station 
designed  to  supply,  over  a  period  of  many  years,  light, 
heat,  and  power  to  people  Hving  in  a  remote  Continent? 
A  longer  time,  it  may  be  hazarded,  than  he  is  accus- 
tomed to  look  ahead. 

Like  the  daily  cooperation  of  Hving  men,  this  coopera- 
tion of  past,  present  and  future  is  essential  to  the 
well-being  of  mankind,  and  yet  it  is  undesigned  and 
unorganized.  As  private  individuals,  men  do,  indeed, 
deliberately  provide  for  their  own  future,  and  for  that 
of  their  kith  and  kin:  as  the  directors  of  businesses, 
they  try  to  forecast  the  trend  of  demand.  But  such 
conscious  calculations  and  dehberate  acts  would  avail 
little  if  they  stood  alone.  They  are  hardly  more  than 
the  necessary  spokes  in  the  great  wheel  which  regulates 
the  relations  of  past,  present  and  future.  The  hub  of  the 
wheel  is  an  elaborate  system  of  borrowing  and  lending, 
essentially  similar  to  the  buying  and  selling  of  com- 
modities. The  private  individual  in  order  to  provide 
for  his  family  or  for  his  old  age  "saves"  and  "invests." 


THE  ECONOMIC  WORLD  13 

But  what  exactly  does  this  mean?  It  means  that  he 
transfers  so  much  purchasing  power,  which  he  might 
have  spent  on  his  personal  pleasures,  to  some  one  else 
in  return  for  the  expectation  of  receiving,  year  by  year 
in  the  future,  he  and  his  heirs  after  him,  a  certain  smaller 
quantity  of  purchasing  power.  The  other  party  to 
the  transaction  will  be,  we  may  suppose,  a  business 
man  who  enters  into  it  because  he  sees  the  opportunity 
of  a  promising  industrial  development,  to  undertake 
which  he  requires  more  purchasing  power  than  he  him- 
self possesses.  And,  because  this  transaction  is  entered 
into,  a  smaller  number  of  us  will  shortly  be  engaged  in 
making  motorcars,  or  gramaphones,  and  a  larger  num- 
ber of  us  in  making  factories  and  machinery,  which  will 
later  enhance  the  world's  productive  power. 

Many  transactions  of  the  kind  take  place  daily  in 
modem  communities,  and  their  multiplicity  gives  rise 
to  a  mass  of  phenomena  with  which  we  are  all  tolerably 
famihar.  We  recognize  a  short-loan  market,  a  stock 
exchange,  a  number  of  "markets"  where  lenders  and 
borrowers  are  brought  together  by  the  aid  of  various 
intermediaries,  such  as  banks,  bill  brokers,  and  stock 
jobbers,  who  correspond  to  dealers  in  commodities. 
Between  these  different  specialized  markets,  we  are 
aware  of  an  interconnection  so  close  and  strong  that  we 
speak  more  generally  of  a  Capital  Market,  of  which  the 
stock  exchange,  the  short-loan  market  and  so  forth,  are 
the  component  parts.  Now,  "market"  is  a  word  which 
was  originally  used  to  denote  a  place  where  tangible 
commodities  were  bought  and  sold;  and  the  more 
closely  we  examine  the  phenomena  of  the  Capital 
Market,  the  more  closely  do  we  perceive  the  profound 


14  SUPPLY  AND  DEMAND 

resemblance  between  the  mechanism  of  borrowing  and 
lending,  and  that  of  buying  and  selling.  Corresponding 
to  the  price  of  a  commodity  is  the  rate  of  interest  (in 
the  short-loan  market  we  actually  call  the  rate  of  dis- 
count "the  price  of  money,"  and  speak  of  money  being 
cheap  or  dear);  and  between  the  rate  of  interest,  the 
demand  for  and  the  supply  of  capital  there  exist  rela- 
tions precisely  similar  to  those  between  price,  demand, 
and  supply  in  commodity  markets.  Above  all  there  is 
the  same  strong  prevailing  trend  towards  an  adjust- 
ment of  demand  and  supply. 

This  fundamental  resemblance  between  two  such 
apparently  incommensurable  things  as  the  buying  of 
material  commodities  and  the  borrowing  of  capital  is 
highly  significant;  it  is  another  instance  of  that  order 
in  the  economic  world,  of  which  the  reader  may  now 
be  growing  weary.  But  so  difficult  is  it  to  see  clearly 
and  fully  something  which  one  sees,  as  it  were,  every 
day  of  one's  life,  that  a  few  more  m.oments  of  reflection 
on  the  special  case  of  capital  will  be  time  well  spent. 
Let  us  revert  then  to  our  fantasy  of  a  world  socialist 
commonwealth;  and  humbly  submit  another  poser 
to  its  supreme  executive.  The  question  this  time  will  be 
whether  some  great  constructional  work,  such,  let  us 
say,  as  the  recently  mooted  Severn  barrage  scheme, 
should  or  should  not  be  undertaken.  Let  us  suppose 
that  the  costs  and  future  benefits  of  the  undertaking 
can  be  estimated  accurately;  and  that  the  problem 
reduces  itself  to  one  of  expending  now  a  sum,  let  us  say, 
of  $100,000,000,  with  the  prospects  of  obtaining  in  the 
future  an  income  of  power,  or  whatever  it  may  be,  worth 
$5,000,000  per  annum.    I  have  assumed  for  the  sake  of 


THE  ECONOMIC  WORLD  15 

simplicity  that  we  shall  still  be  reckoning  in  terms  of 
money,  though  possibly  the  executive  may  have 
substituted  Marxian  labor  units;  but  it  is  quite  im- 
material to  the  present  argument  what  the  measuring 
rod  may  be.  The  point  to  be  observed  is,  that  it  is 
impossible  to  tackle  the  problem  at  all  without  the 
conception  of  a  rate  of  interest.  For  suppose  that  you 
tried  to  do  without  it,  and  said,  "We  shall  take  a  long 
view.  The  interests  of  the  future  are  no  less  our  concern 
than  those  6f  the  present;  we  shall  not  discriminate 
between  them.  We  shall  regard  as  an  enterprise  worthy 
to  be  undertaken  whatever  promises  to  yield  in  the 
course  of  time  a  return  larger  than  the  outlay."  Where 
will  this  lead  you?  The  particular  proposal  set  out 
above  would  clearly  pass  the  test;  for  in  twenty  years 
the  resultant  benefits  would  have  added  up  to  a  figure 
equivalent  to  the  initial  cost.  But  equally  clearly, 
the  cost  might  have  been  more  than  $100,000,000;  it 
might  have  been  $250,000,000,  $500,000,000,  whatever 
figure  you  care  to  take,  and  if  you  extend  the  period 
similarly  to  fiftj'^  or  one  hundred  years,  sooner  or  later 
the  gains  would  top  the  cost.  Now  there  is  no  limit  to 
the  enterprises  which  would  pay  their  way  on  this 
basis;  and  it  would  be  quite  impossible  to  undertake 
them  all.  For  they  would  swallow  up  all  and  more  than 
all  your  labor  and  your  materials,  and  would  leave 
you  with  no  resources  with  which  to  meet  the  recurrent 
daily  wants  of  men.  Clearly,  then,  in  some  way  or 
other,  you  must  pick  and  choose,  you  must  reject  some 
enterprises  as  insufficiently  worth  while.  But  how 
would  you  proceed  to  choose?  Without  a  clear  prin- 
ciple, a  simple  criterion  to  guide  you,  you  would  be 


16  SUPPLY  AND  DEMAND 

plunged  in  utter  chaos.  You  could  not  say,  "Let  all 
proposals  involving  capital  expenditure  be  submitted 
to  a  central  committee,  who  shall  compare  them  with 
one  another  in  a  sort  of  competitive  examination  and, 
after  deciding  the  number  of  applications  they  can  pass 
on  the  basis  of  the  volume  of  resources  which  they  can 
devote  to  the  future,  award  the  places  to  those  which 
head  the  Ust."  Such  a  prospect  is  a  nightmare  of 
officialism  and  delay.  You  would  be  driven  to  for- 
mulate a  simple,  intelligible  rule  or  measure,  and  leave 
that  rule  to  be  applied  by  the  unfettered  judgment  of 
innumerable  men  to  individual  problems,  as  and  when 
they  arose.  And  for  such  a  rule  or  measure,  you  could 
not  do  better  than  a  rate  of  interest;  you  would  have  to 
lay  it  down  that  only  those  projects  should  be  ap- 
proved which  promised  a  return  of  6  per  cent,  or  what- 
ever it  might  be.  Even  in  deciding  what  it  should  be, 
the  limits  of  your  choice  would  be  narrowly  confined. 
If,  for  instance,  you  fixed  on  1  or  2  per  cent,  you  would 
probably  discover  that  you  had  not  achieved  your 
object,  that  the  undertakings  for  distant  returns  which 
passed  this  test,  still  consumed  far  more  resources  than 
you  could  spare.  You  would  be  compelled  then  to  raise 
the  rate  until  it  had  cut  these  enterprises  down  within 
manageable  limits.  But,  once  more,  what  essentially 
would  you  be  doing?  You  would  be  using  the  instru- 
ment of  the  rate  of  interest  to  adjust  the  demand  for 
and  supply  of  capital,  though  indeed  the  interest  might 
not  be  paid  away  as  now  to  private  individuals.  You 
would  be  reproducing  by  the  method  of  deliberate  trial 
and  error,  the  adjustments  which  occur  automatically 
as  things  are,  in  the  actual  world.    Once  again  the  most 


THE  ECONOMIC  WORLD  17 

perfectly  contrived  Utopia  would  be  compelled  to  pay 
to  the  unorganized  cooperation  of  our  epoch  the  sin- 
cerest  flattery  of  imitation. 

§  6.  The  Fundamental  Character  of  many  Economic 
Laws.  But  again  perhaps  a  word  of  warning  may  be 
desirable.  There  is  much  controversy  in  these  days 
about  something  called  "Capitalism"  or  "The  capitalist 
system."  When  these  words  are  used  with  any  pre- 
cision, they  usually  refer  to  the  arrangement  so  prev- 
alent at  present,  whereby  the  ownership  and  sole 
ultimate  control  of  a  business  rests  with  those  who  hold 
its  stocks  and  shares.  There  is  much  to  be  said  upon 
the  merits  and  demerits  of  this  system;  something  will 
perhaps  be  said  upon  the  matter  in  the  fifth  volume  of 
this  series;  but  I  shall  not  discuss  it  here.  Nothing 
that  I  have  said  so  far  has  any  real  bearing  on  it  what- 
soever; to  suppose  that  it  has,  is  indeed  to  miss  the 
whole  point  of  this  chapter. 

The  order,  which  I  have  sought  to  reveal,  pervad- 
ing and  moving  the  most  diverse  phenomena  of  the 
economic  world,  would  be  a  far  less  noteworthy  and 
impressive  thing  were  it  merely  the  peculiar  product  of 
capitalism.  Merchant  adventurers,  companies,  and 
trusts;  Guilds,  Governments  and  Soviets  may  come  and 
go.  But  under  them  all,  and,  if  need  be,  in  spite  of  them 
all,  the  profound  adjustments  of  supply  and  demand  will 
work  themselves  out  and  work  themselves  out  again 
for  so  long  as  the  lot  of  man  is  darkened  by  the  curse 
of  Adam. 


CHAPTER  II 

THE   GENERAL   LAWS   OF   SUPPLY   AND 
DEMAND 

§L  Preliminary  Statement  of  Three  Laws.  The  recogni- 
tion of  order  in  any  branch  of  natural  phenomena  is 
but  the  prelude  to  the  formulation  of  a  set  of  laws, 
the  simpler  as  the  order  is  more  universal,  which  de- 
scribe, and  as  we  say,  explain  it.  Thus  the  perception 
of  the  even,  elliptical  courses  of  the  heavenly  bodies  led 
to  the  statement  of  the  law  of  gravitation  and  the  laws 
of  motion. 

In  economics,  similar  laws  have  long  since  been 
enunciated,  and  have  proved  themselves  such  valuable 
instruments  for  the  understanding  of  the  daily  problems 
of  the  workaday  world,  that  they  have  been  woven 
into  the  texture  of  our  ordinary  speech  and  thought. 
I  have  already  touched  upon  them  in  the  preceding 
chapter.  But  it  is  now  desirable  to  set  them  out  in 
order,  in  the  most  concise  and  formal  manner  possible. 

I.  When,  at  the  price  ruling,  demand  exceeds 
supply,  the  price  tends  to  rise.  Conversely 
when  supply  exceeds  demand  the  price  tends 
to  fall. 

II.     A  rise  in  price  tends,  sooner  or  later,   to 
decrease   demand   and   to   increase   supply. 
Conversely  a  fall  in  price  tends,  sooner  or 
18 


GENERAL  LAWS  19 

later,  to  increase  demand  and  to  decrease 
supply. 

ni.     Price  tends  to  the  level  at  which  demand  is 
equal  to  supply. 

These  three  laws  are  the  cornerstone  of  economic 
theory.  They  are  the  framework  into  which  all  analysis 
of  special,  detailed  problems  must  be  fitted.  Their 
scope  is  very  wide.  I  have  purposely  refrained  from 
introducing  into  my  statement  of  them  any  reference 
to  commodities;  for  they  extend  far  beyond  com- 
modities. Subject  to  an  important  qualification,  they 
apply  to  capital,  the  price  paid  for  the  use  of  capital 
being  what  we  call  the  rate  of  interest.  They  apply 
hardly  less  to  "services,"  to  the  remuneration  of  labor 
of  every  kind  and  grade.  People  sometimes  protest 
warmly  against  the  idea  of  treating  labor  "  like  a  com- 
modity." If  this  indignation  expresses  no  more  than  a 
belief  that  in  matters  concerning  conditions  of  work, 
and  relations  between  employees  and  the  management, 
the  sensibilities  of  human  nature  should  be  taken  into 
due  account,  it  is  based  on  elementary  decency  and 
conunonsense.  But  if,  as  sometimes  appears,  it  is 
directed  against  the  fact  that  the  remuneration  of 
labor  is  controlled  by  the  laws  of  supply  and  demand, 
it  is  a  mere  baying  at  the  moon,  with  singularly  little 
provocation.  For  these  laws  are  in  no  way  peculiar  to 
commodities,  and  it  is  no  one's  fault  that  they  include 
commodities  too  within  their  scope. 

But  let  us  go  back  to  the  laws  themselves,  and  probe 
them  and  dissect  them,  and  turn  them  this  way  and 
that,  so  that  we  may  perceive  their  full  content,  and 


20  SUPPLY  AND  DEMAND 

grasp  it  firmly  in  our  minds.  The  third  law  implies  a 
prevailing  tendency  for  demand  to  be  equal  to  supply. 
This  tendency,  as  was  suggested  in  Chapter  I,  can  be 
verified  by  anyone  from  his  experience  and  observation 
(provided  he  is  a  reasonable  person,  and  not  the  tire- 
some kind  who  would  dispute  the  law  of  gravitation 
because  he  sees  that  a  feather  falls  to  the  ground  more 
slowly  than  a  stone).  But  it  can  also  be  deduced  as  a 
corollary  from  the  two  preceding  laws;  and  to  regard  it 
in  this  way  will  help  us  to  appreciate  its  significance. 
Start,  for  instance,  by  supposing  that  demand  is  in 
excess  of  supply.  Then  the  price  will  tend  to  rise.  After 
the  price  has  risen,  the  supply  will  become  larger,  while 
the  demand  will  fall  away.  The  excess  of  demand 
with  which  we  started  will  thus  clearly  be  diminished. 
But  if  there  remains  any  portion  of  this  excess,  the 
same  reactions  will  continue;  the  price  will  rise  further, 
and  for  the  same  reason;  demand  will  be  further 
checked  and  supply  further  stimulated.  In  other  words, 
these  forces  must  persist  until  the  entire  excess  of 
demand  over  supply  is  eliminated.  If  we  start  by 
supposing  supply  to  exceed  demand,  the  converse  chain 
of  sequences  will  operate.  Now  these  very  simple  steps 
of  reasoning  illuminate  the  nature  of  the  normal  equi- 
librium of  demand  and  supply.  They  reveal  that  the 
equilibrium  is  established  and  maintained  by  the 
agency  of  changes  in  price,  and  they  enable  us  to  lay  it 
down  as  perhaps  the  most  important  thing  that  can  be 
said  about  the  price  of  anything  that  it  will  tend  to  be 
such  as  will  equate  demand  and  supply.  But  that  is  not 
all  that  they  reveal.  They  reveal  also  the  extreme 
dependence  of  both  demand  and  supply  upon  price. 


GENERAL  LAWS  21 

Now  this  is  a  fact  which  it  is  most  important  to  realize 
vividly.  It  is  apt  to  be  obscured  by  customary  modes 
of  speech.  In  ordinary  times  the  prices  of  most  com- 
modities and  services  do  not  change  by  very  much, 
imless  indeed  over  a  long  period  of  years;  the  amounts 
demanded  and  supplied  may  therefore  seem  to  main- 
tain a  fairly  constant  level;  and  we  may  be  tempted  to 
speak  of  Great  Britain  producing  so  many  million  tons 
of  coal,  or  America  consuming  so  many  millions  of 
motor-cars  per  annum,  almost  as  though  these  quan- 
tities were  independent  of  price  considerations.  But 
we  should  never  forget  that  there  is  no  service  or  com- 
modity produced  by  man,  however  essential  it  may 
seem,  the  demand  for  or  the  supply  of  which  might  not 
be  reduced  to  nothing,  if  the  price  were  sufficiently 
raised  on  the  one  hand,  or  lowered  on  the  other.  How 
easy  it  is  sometimes  to  forget  this  simple  truth  may  be 
seen  from  the  mistake  so  commonly  made  of  supposing, 
because  the  peoples  of  Central  Europe  were  left,  on  the 
cessation  of  the  war,  starving  and  destitute  of  the 
means  of  life  and  the  materials  of  work,  that  they  must 
necessarily  become  heavy  purchasers  of  imported 
goods;  without  pausing  to  consider  whether  the  prices 
were  such  as  they  could  afford  to  pay. 

§  2.  Diagrams  and  their  Uses.  It  will  help  to  prevent 
mistakes  like  this  and  more  generally  to  make  sharp  and 
clear  the  fundamental  relations  which  exist  between 
demand,  supply  and  price,  if  we  exhibit  them  pictorially 
in  the  form  of  a  diagram.  Such  diagrams  are  of  great 
service  in  many  parts  of  economic  theory,  not  because 
they  can  prove  anything  which  could  not  be  proved 


22 


SUPPLY  AND  DEMAND 


otherwise,  but  because,  being  really  a  simpler  medium 
of  expression  than  words,  they  enable  the  mind  to 
grasp  more  readily  and  to  retain  more  vividly  the  essen- 
tial facts  of  complex  relations. 

In  Fig.  1  the  curve  DD'  represents  the  conditions  of 
demand.  It  is  supposed  to  be  drawn  in  such  a  way  that 
if  any  point,  Q,  be  taken  on  the  curve,  and  the  perpen- 


FlG.  1. 

dicular  QN  be  drawn  to  meet  the  base  line,  or  axis  OX, 
then  ON  will  represent  the  amount  that  will  be  de- 
manded at  a  price  represented  by  QN  (or  0/) .  In  other 
words,  distances  measured  along  OY  represent  prices, 
and  distances  measured  along  OX  represent  quantities 
of  the  commodity,  or  service,  or  whatever  it  may  be. 
Clearly,  then,  the  demand  curve,  DD',  must  slope 
downwards  from  left  to  right,  since  the  lower  the 
price  asked,  the  greater  will  be  the  amount  demanded. 
Similarly  the  curve  SS'  represents  the  conditions  of 


GENERAL  LAWS  23 

supply.  It  is  supposed  to  be  so  drawn  that  if  any 
point  q  be  taken  upon  it,  and  the  perpendicular  gN 
be  drawn  to  meet  OX,  then  ON  will  represent  the 
amount  that  will  be  supplied  at  a  price  represented  by 
5N  (or  Ok).  Equally  clearly  this  supply  curve  must 
slope  upwards  from  left  to  right,  since  the  higher  the 
price  obtainable,  the  greater  will  be  the  quantity 
offered.  Take  the  point  P  where  the  two  curves  meet, 
and  draw  the  perpendicular  PM  to  meet  OX,  Then 
the  third  law  enunciated  at  the  beginning  of  this 
chapter  corresponds  to  the  statement  that  PM  or  Om 
will  represent  the  price  at  which  the  commodity  or 
service  will  be  exchanged. 

It  can  readily  be  seen  that  no  other  price  could  be 
maintained.  For  suppose  the  price  to  be  less  than  Om, 
suppose  it  to  be  O/c,  then,  at  this  price,  ON  (or  kq)  will 
be  the  amount  supplied,  and  kr  the  amount  demanded. 
The  demand  will  thus  exceed  the  supply,  and  the 
price  will  tend  to  rise,  i.  e.  to  move  upwards  towards 
Om.  Similarly  if  we  suppose  the  price  to  be  01,  which 
is  larger  than  Om,  the  supply  (ZR)  will  exceed  the 
demand  (ZQ)  and  the  price  will  fall  downwards  towards 
Om.  Thus,  again,  we  have  deduced  Law  III  from 
Laws  I  and  II  with  the  form  and  precision  of  a 
proposition  in  Euclid.  Now,  when  once  the  eye  has 
become  familiar  with  this  diagram,  it  ought  to  be 
impossible  for  the  mind  to  lose  even  momentarily  its 
grip  on  the  fact  that  demand  and  supply  are  both 
dependent  upon  price.  For  these  curves  do  not  repre- 
sent any  particular  amounts;  they  represent  a  series  of 
relations  between  amount  and  price;  if  the  price  is 
QN  the  amount  demanded  is  ON,  and  so  forth.    The 


24  SUPPLY  AND  DEMAND 

terms  demand  and  supply  in  the  sense,  in  which  I 
have  been  using  them,  of  the  respective  amounts  de- 
manded and  supplied  are,  indeed,  strictly  meaning- 
less without  reference  to  some  particular  price.  The 
reference  may  sometimes  be  implicit;  but,  whenever 
there  is  a  chance  of  ambiguity,  it  should  be  expUcitly 
made. 

§  3.  Ambiguities  of  the  Expressions,  "Increase  in  De- 
mand/' etc.  It  is  the  more  important  to  be  precise 
upon  this  point,  in  that  there  is  a  further  possible 
confusion  which  we  have  now  to  consider.  Demand 
and  supply,  as  we  have  seen,  are  dependent  upon 
price;  but  equally  clearly  they  are  dependent  upon 
other  things  as  well.  Demand  depends  upon  the  needs, 
tastes  and  habits  of  the  people,  as  well  as  upon  the 
length  of  their  purse;  supply  depends  upon  such  things 
as  the  cost  of  production  in  the  case  of  commodities. 
None  of  these  things  are  constant  factors,  all  of  them 
are  liable  to  change,  and  it  may  well  happen  that  we 
shall  want  to  consider  in  some  concrete  problem  the 
probable  consequences  of  such  a  change.  Now  the 
most  usual  and  natural  way  of  describing  such  changes 
in  the  medium  of  words  is  to  use  the  expression  "in- 
crease" or  "decrease  in  demand,"  and  "increase" 
or  "decrease  in  supply,"  the  same  expressions,  which 
we  employed  before  to  describe  the  consequences  of  a 
change  in  price.  This  identity  of  language  conceals 
a  fundamental  distinction  between  the  phenomena 
described;  and  to  make  this  distinction  plain  we  cannot 
do  better  than  revert  to  our  diagrammatic  presentation 
of  the  laws. 


GENERAL  LAWS 


25 


In  Fig.  2  we  start  as  before  with  our  demand  curve, 
and  supply  curve,  cutting  one  another  at  the  point  P. 
We  then  suppose  that  some  alteration  takes  place  in 
the  conditions  of  demand;  there  has  been  a  growth 
in  the  general  taste  for  the  commodity  or  service,  and 
the  demand,  as  we  say,  has  increased  accordingly. 


Fio.  2. 

How  is  this  fact  to  be  represented  in  the  diagram? 
Plainly  not  by  taking  another  point  on  the  curve,  DD', 
at  a  further  distance  from  OY.  For  this  would  merely 
indicate  the  larger  amount  that  would  be  taken,  if  the 
conditions  of  demand  had  remained  unaltered  but  the 
sellers  had  reduced  their  prices.  The  correct  way  of 
representing  the  change  we  have  supposed  is  to  con- 
struct a  new  demand  curve  (in  the  figure,  the  dotted 


26  SUPPLY  AND  DEMAND 

curve  dd'),  lying  at  every  point  above  the  old  demand 
curve.  For  this  indicates  that  larger  quantities  will 
be  purchased  at  the  old  prices,  which  is  exactly  what 
we  want  to  represent.  Similiarly  if  we  wish  to  represent 
a  change  in  the  conditions  of  supply,  such  as  might 
result,  in  the  case  of  a  commodity,  from  a  tax  imposed 
on  its  production,  we  must  draw  a  new  supply  curve, 
ss\  which  in  the  case  supposed,  must  lie  everywhere 
above  the  old  supply  curve.  On  the  other  hand,  the 
decrease  or  increase  in  demand  or  supply,  resulting 
from  a  change  in  price,  is  represented  simply  by  a 
shifting  of  the  equilibrium  from  one  point  to  another  on 
the  same  curve.  The  striking  pictorial  contrast  be- 
tween a  movement  from  one  curve  to  another,  and  a 
movement  along  the  same  curve  should  help  to  make 
vivid  to  our  minds  the  fundamental  distinction  between 
a  change  in  the  conditions  of  demand,  arising  from  new 
tastes,  enhanced  purchasing  power,  etc.;  and  a  mere 
change  in  the  amount  purchased  resulting  from  an 
alteration  in  the  price  which  the  sellers  ask.  Words, 
as  this  necessarily  cumbrous  sentence  shows,  are  a 
clumsy  instrument  for  the  expression  of  abstract 
relations;  it  is  not  very  easy  to  see  which  words  in  a 
sentence  are  the  significant,  commanding  ones,  and 
which  are  performing,  as  it  were,  ordinary  routine 
duties.  A  diagram  is  not  exposed  to  similar  ambigui- 
ties of  emphasis. 

The  particular  distinction,  to  which  attention  has 
been  called,  is  important.  The  reader  who  has  grasped 
it  clearly  will  be  able  to  perceive  many  instances  of  the 
confusion  arising  out  of  its  neglect  in  the  ordinary 
discussions  of  economic  questions  which  take  place 


GENERAL  LAWS  27 

in  the  press  and  on  the  platform.  It  is  not  uncommon, 
for  instance,  for  an  argument  to  run  something  like 
this:  "The  effect  of  a  tax  on  this  conmiodity  might 
seem  at  first  sight  to  be  an  advance  in  price.  But  an 
advance  in  price  will  diminish  the  demand;  and  a 
reduced  demand  will  send  the  price  down  again.  It 
is  not  certain,  therefore,  after  all,  that  the  tax  will 
really  raise  the  price."  A  glance  at  the  diagram  will 
keep  us  out  of  such  a  bog  of  sophistry  and  muddle. 
For  if  we  suppose  the  amount  of  the  tax  per  unit  of  the 
commodity  to  be  represented  by  Ss,  the  curve  ss' 
(drawn,  as  it  is,  roughly  parallel  to  SS')  will  represent 
the  new  conditions  of  supply  after  the  tax  has  been 
imposed.  The  new  position  of  equilibrium  will  be 
given  by  the  point  P',  where  ss'  cuts  DD',  the  demand 
curve.  Now  P'  lies  to  the  left  of  P  the  old  point  of 
equilibrium;  hence,  since  DD'  must  slope  downwards 
from  left  to  right,  it  is  clear  that,  if,  as  it  is  fair  here  to 
assume,  the  conditions  of  demand  have  remained  unal- 
tered, the  new  price  P'M',  must  be  greater  than  the  old. 

§  4.  Reactions  of  Changes  in  Demand  and  Supply  on 
Price.  Having  novv^  made  clear  the  meaning  that  must 
be  attached  to  the  terms,  let  us  consider  the  question 
which  naturally  arises,  whether  we  can  lay  down  any 
general  propositions  or  laws  as  to  the  effect  upon 
price,  of  an  increase  or  decrease  in  demand  or  supply. 
Another  glance  at  the  diagram  suggests  that  we  can. 
An  increase  in  demand  is  represented  in  Fig.  2  by  a 
movement  from  DD'  to  dd',  which  cuts  the  supply 
curve,  SS',  at  p,  to  the  right  of  P.  Since  the  supply 
curve  (drawn,  as  it  is  best  to  draw  it,  to  represent  the 


28  SUPPLY  AND  DEMAND 

amount  which  will  be  supplied  in  response  to  a  given 
price)  must  always  slope  upwards  from  left  to  right, 
the  new  price,  pm,  must  be  greater  than  the  old,  PM. 
Conversely  a  decrease  in  demand  is  represented  by  a 
movement  from  dd'  to  DD',  and  the  new  price  is 
seen  to  be  less  than  the  old.  We  have  already  seen 
that  a  decrease  in  supply,  which  is  represented  by  a 
movement  from  SS'  to  ss'  results  in  a  higher  price; 
and  it  is  the  obvious  converse  that  an  increase  in 
supply  will  have  the  opposite  effect.  It  would  seem 
then  that  we  might  lay  down  quite  generally  that  an 
increase  in  demand  or  a  decrease  in  supply  will  raise  the 
price  while  a  decrease  in  demand  or  an  increase  in 
supply  will  lower  it. 

But  here  it  is  necessary  to  be  cautious.  All  con- 
clusions as  to  the  effects  of  causes  are  necessarily  based, 
implicitly,  if  not  explicitly,  upon  the  assumption 
" other  things  being  equal.' '  This  method  of  reasoning, 
which  some  people  appear  to  find  so  irritating  in  the 
economic  sphere,  and  as  they  say  so  "theoretical" 
and  "unreal,"  is  one  which  they  adopt  readily  enough 
in  every  other  department  of  life.  No  one,  for  instance, 
objects  to  the  statement  that  the  sun,  when  it  comes 
out,  makes  a  room  warmer,  although  it  may  very 
well  happen,  if  a  fire  is  dying  at  the  same  time,  that 
the  room  grows  colder  in  point  of  fact.  For  in  our 
general  statement  we  assume  implicitly  that  "other 
things"  such  as  fires,  are  unchanged.  But  assumptions 
of  this  kind  are  legitimate  only  when  there  is  no  reason 
to  suppose  that  the  cause,  the  effects  of  which  are 
being  studied,  will  itself  produce  a  change  in  the  "other 
things."    If  (as  I  have  often  been  told;  I  really  do  not 


GENERAL  LAWS  29 

know  if  it  is  true)  the  rays  of  the  sun  help  to  put  a 
fire  out,  the  statement  made  above  would  be  the  better 
for  some  qualification. 

Now  we  can  only  say  that  an  increase  in  demand 
raises  price  if  we  assume  the  conditions  of  supply  (as 
represented  by  the  supply  curve)  to  remain  unchanged. 
But  in  practice,  an  increase  in  demand  may  cause  a 
change  in  the  conditions  of  supply.  An  increase,  for 
instance,  in  the  demand  for  a  commodity  may  give  rise 
to  a  revolution  in  the  methods  of  production,  to  the 
introduction  of  labor-saving  machinery  and  so  forth, 
which  will  eventually  result  in  the  commodity  being 
produced  more  cheaply.  It  will  certainly  take  a  con- 
siderable time  before  reactions  of  this  kind  can  exert 
an  appreciable  influence;  and  we  can,  therefore,  feel 
reasonably  sure  that  over  a  short  period  an  increase  in 
demand  will  raise  the  price.  But  we  cannot  be  sure 
what  the  ultimate  effect  will  be.  A  similar  alteration  in 
the  condition  of  demand  is  less  likely  to  result  from  an 
increase  or  decrease  in  supply;  but  it  may  conceivably 
occur.  We  must,  therefore,  be  careful  to  qualify  any 
general  propositions  which  we  lay  down  in  this  connec- 
tion, by  explicit  reference  to  a  short  period  of  time. 
We  can  add  the  following  to  our  body  of  laws: — 

IV.  An  increase  in  demand,  or  a  decrease  in  supply 
will  tend  to  raise  the  price  for  a  short  period  at 
least.  Conversely  a  decrease  in  demand,  or  an 
increase  in  supply  will  tend  to  lower  the  price 
for  a  short  period  at  least. 

This  law,   Hke  the  others,   applies  to   commodities, 
services,  capital,  to  anything  which  can  be  said,  liter- 


30  SUPPLY  AND  DEMAND 

ally,  or  by  analogy,  to  have  a  price.  "A  short  period" 
is,  however,  a  vague  expression  and,  since  precision  is 
the  hallmark  of  an  important  law,  we  must  accord  to 
this  one  a  status  inferior  to  that  which  the  preceding 
three  can  rightly  claim. 

§  5.  Some  paradoxical  reactions  of  price  changes  on 
supply.  Let  us  turn,  though,  once  more  to  these 
earlier  laws,  and  with  a  heightened  critical  sense  let  us 
submit  them  to  the  test  of  the  whole  gamut  of  our 
experience,  and  see  if  in  any  of  them  we  can  find  the 
smallest  flaw.  The  first  of  them  will  pass  through 
the  ordeal — let  each  reader  prove  it  for  himself — 
unscathed.  The  second  will  emerge  with  a  few  hairs, 
as  it  were,  singed.  It  tells  us,  for  instance,  that  a  rise 
in  price  will  tend  to  augment  the  supply.  Now  there 
are  some  things  the  supply  of  which  camiot  possibly 
be  augmented ;  these  are  the  capital  resources  of  nature, 
of  which  land  is  the  most  important  for  our  present 
purpose.  Land  is  bought  and  sold,  it  commands  a 
price.  In  a  certain  sense,  it  may  be  said  to  be  possible 
to  increase  the  supply  of  land,  in  response  to  a  rise  in 
price,  by  drainage  and  reclamation  schemes;  and  it 
will  certainly  happen  that  a  rise  in  the  price  which 
land  can  command  for  any  particular  purpose  will 
increase  the  amount  which  is  devoted  to  that  purpose. 
But,  speaking  broadly,  the  supply  of  land  available 
for  purposes  of  every  kind  is  a  fixed  unvarying  factor, 
with  an  inertia  which  the  cajolery  of  price-changes  is 
powerless  to  disturb.  This  is  a  most  important  fact, 
and  it  gives  rise  to  some  peculiar  features  of  the  price 
and  rent  of  land,  which  we  shall  have  to  consider  later 


GENERAL  LAWS  31 

as  a  separate  problem.  It  constitutes  a  limiting  case 
rather  than  an  exception  to  the  general  law.  But  we 
have  not  yet  done  with  the  reactions  of  price  upon 
supply.  In  the  case  of  capital,  the  nature  of  those  re- 
actions has  been  much  discussed  as  a  highly  controver- 
sial question.  That  a  rise  in  the  rate  of  interest  will 
cause  some  people  to  save  more  than  before,  is  gener- 
ally admitted ;  but  it  is  pointed  out  that  the  effect  upon 
others  may  be  the  exact  opposite,  because  it  means  that 
they  do  not  need  to  save  so  much  to  acquire  the  same 
future  annual  income.  It  is  unwise  to  say  dogmatically 
that  the  former  tendency  outweighs  the  latter;  though 
upon  the  whole  it  seems  highly  probable  that  it  does. 
We  cannot,  therefore,  in  this  case  feel  confident  that  a 
change  in  price  will  react  upon  supply  in  the  manner 
which  our  law  indicates.  Similarly  it  is  possible  to 
argue  that  a  rise  in  the  general  level  of  real  wages  may 
reduce  the  supply  of  labor,  even,  or  some  might  say 
particularly,  if  the  term  is  used  to  denote  not  the 
number  of  workpeople,  but  the  quantity  of  work  done. 
For  there  may  be  a  tendency  for  workpeople,  when 
more  comfortably  off,  to  work  less  regularly  or  less 
hard.  Here  again  we  cannot  be  sure.  In  none  of 
these  cases,  however,  including  that  of  land,  is  there 
any  reason  to  doubt  that  a  rise  in  price  will  diminish 
demand,  or  conversely  that  a  fall  will  increase  it.  Since, 
therefore,  in  the  reasoning  by  which  we  deduced  the 
third  law,  the  conclusion  will  hold  good,  even  if  the 
effects  of  price-changes  on  supply  are  of  the  above 
paradoxical  kind,  provided  that  they  do  not  con- 
tinually outweigh  the  effects  upon  demand,  there  is  no 
reason  to  cast  doubt  on  the  sohdity  of  Law  III,  which, 


32  SUPPLY  AND  DEMAND 

indeed,  as  we  suggested  before,  commends  itself  directly 
to  experience.  But  Law  II  seems  now,  perhaps,  some- 
what the  worse  for  wear. 

The  damage,  however,  is  not  considerable.  For  in 
each  case  the  uncertainty  arises  only  when  we  are 
dealing  with  one  of  the  factors  of  production,  land, 
labor  or  capital,  regarded  as  a  whole.  If  we  are  dealing 
with  the  capital  available  for  a  particular  industry,  a 
rise  in  the  rate  of  profit  in  that  industry  will  certainly 
increase  the  supply  of  capital  available  there;  for  it  will 
tend  to  attract  savings  that  might  otherwise  have  been 
employed  elsewhere.  We  can  even  be  fairly  sure  that 
an  increase  in  the  general  rate  of  interest  prevailing  in 
any  particular  country  will  increase  the  total  supply 
of  capital  available  for  the  businesses  of  that  country, 
since  capital  has  in  modem  times  acquired  a  consider- 
able migratory  power.  In  the  case  of  labor,  we  cannot 
go  so  far  as  this;  but  here,  too,  there  is  no  doubt  that  an 
increase  in  the  remuneration  offered  in  any  particular 
occupation  will  attract  an  increased  labor  supply 
(always  supposing,  of  course,  that  "other  things  are 
equal").  No  similar  difficulty  arises  for  land,  labor 
or  capital,  as  regards  the  effect  of  price-changes  on 
demand;  while  for  ordinary  conunodities  there  is  no 
such  difficulty  on  the  side  either  of  demand  or  of 
supply.  Hence  the  only  qualification  which  the 
strictest  accuracy  would  require  us  in  this  connec- 
tion to  attach  to  our  statement  of  Law  II  is  the 
postscript: — 

"Except  that,  in  the  case  of  land,  the  aggregate  supply  is 
unalterable;  while  in  the  case  of  capital  or  labor  we  cannot  be 
sure  how  price-changes  will  affect  the  aggregate  supply." 


GENERAL  LAWS  33 

Much  significance  attaches  to  these  exceptions,  as 
later  will  appear. 

§  6.  The  Disturbances  of  Monetary  Changes.  But  let 
us  still  keep  a  critical  eye  on  Law  II,  and  submit  it 
to  another  flashlight  from  our  practical  experience. 
The  recent  world  war  made  us  all  acutely  aware  of  a 
remarkable  rise  in  the  price  of  almost  everything, 
which  yet  did  not  seem  to  diminish  appreciably  the 
demand.  The  explanation  of  this  paradox  is  not 
difficult  to  find.  There  was  an  immense  increase  in  the 
volume  of  nominal  purchasing  power,  due  to  a  complex 
set  of  causes,  of  which  ''currency  inflation"  may  be 
taken  as  the  symbol.  Now  perhaps  we  are  entitled  to 
assume  the  absence  of  such  currency  changes  as  part  of 
the  "other  things  being  equal"  which  is  always  under- 
stood as  implied.  But  it  is  rash  to  take  this  particular 
assumption  for  granted,  more  especially  in  these  days. 
Already  people  are  too  apt  to  speak  as  though  the 
trade  depression  (which  as  these  pages  are  written 
holds  us  in  its  grip)  cannot  pass  away  until  pre-war 
prices  are  restored,  ignoring  altogether  the  great  and 
probably  permanent  increase  in  nominal  purchasing 
power  which  the  war  has  left  behind  it.  It  would  be 
safer,  therefore,  to  add  explicitly  to  Law  II  the  reserva- 
tion, "Assuming  that  there  is  no  change  in  the  general 
volume  of  purchasing  power." 

Monetary  and  allied  questions  will  form  the  subject 
of  the  second  volume  of  this  series.  It  must  not  be 
supposed  that  our  general  laws  have  no  bearing  on 
them.  On  the  contrary,  Law  I,  which  all  this  time  has 
remained  serene  and  undisturbed  by  the  occasional  dis- 


34  SUPPLY  AND  DEMAND 

comfitures  of  Law  II,  is  the  gateway  through  which  all 
questions  of  currency,  banking  and  the  foreign  ex- 
changes should  be  approached.  It  is  well  to  note,  as  an 
inexorable  corollary  of  Law  I,  that  prices  can  rise  only 
if  demand  exceeds  supply,  and  fall  only  if  supply  ex- 
ceeds demand;  and  hence  that  it  is  only  through  the 
agency  of  changes  in  the  demand  for  and  supply  of 
conunodities  and  services  that  an  inflation  or  deflation 
of  the  currency  can  influence  the  price  level.  Further, 
since  a  condition  of  things  in  which  supply  generally 
exceeds  demand  spells  what  we  laiow  and  fear  as  a  trade 
depression,  it  may  be  well  to  note  at  once  that  falling 
prices  and  unemployment  are  inseparable  bedfellows. 
For  we  are  far  too  apt  to  shut  our  eyes  to  these  un- 
pleasant truths.  But  we  cannot  pursue  them  further 
here;  and  in  the  remainder  of  this  volume  we  shall 
not  be  concerned  (except,  perhaps,  incidentally)  with 
questions  affecting  the  general  level  of  prices  or  of  pur- 
chasing power;  but  rather  with  the  relation  which  the 
price  of  one  commodity  bears  to  that  of  another,  with 
the  rate  of  interest  (which  being  a  rate  per  cent  is  not 
essentially  dependent  on  the  price  level),  with  "real" 
wages  (as  distinct  from  money  wages)  and  the  like. 

§  7.  The  Trade  Cycle.  But  our  reference  to  trade 
depressions  suggests  a  final  comment  on  Law  11.  One 
small  qualification  was  embodied  in  our  original  state- 
ment of  it,  namely  the  words  "sooner  or  later."  A  rise 
in  price  may  not  check  the  demand  immediately  (even 
if  the  printing  presses  are  standing  idle  in  the  Treas- 
uries); it  may  actually  stimulate  it  for  a  time.  For 
people  may  fear  that  the  price  will  rise  further  still,  and 


GENERAL  LAWS  35 

hasten  to  buy  what  they  must  buy  before  very  long. 
Sellers  may  share  the  same  opinion,  and  be  reluctant  on 
their  side  to  part.  When  prices  are  falling  the  roles  are 
reversed,  and  we  are  likely  to  see  the  sellers  tumbling 
over  one  another  in  a  frantic  eagerness  to  sell,  the 
buyers  wary  and  aloof.  Sooner  or  later,  indeed,  these 
tendencies  must  dissolve  and  disappear;  but  they  may 
persist  for  a  longer  period  than  might  seem  probable 
at  first.  For  the  raw  material  of  one  trade  is,  as  we  say, 
the  finished  product  of  another.  The  demand  for  one 
thing  gives  rise  to  a  demand  for  other  things,  for  the 
labor  with  which  to  make  them,  and  so  on  in  an  ex- 
panding circle.  A  sympathy,  subtle  and  intense, 
unites  the  business  world,  and  a  wave  of  depression  or 
animation  arising  in  any  quarter  may  spread  itself  far 
and  wide,  heightened  by  the  <5usts  of  human  hope  and 
fear,  and  continue  long  before  its  influence  is  spent. 

Here  we  are  upon  the  threshold  of  one  of  the  most 
striking  and  formidable  of  economic  facts,  the  regular 
alternation  of  periods  of  good  and  bad  trade,  each  veiy 
widespread,  if  not  world-wide,  in  its  range,  each  com- 
prising certain  regular  phases  of  acceleration  and  decay, 
and  each  infallibly  yielding  sooner  or  later  to  the  other. 
The  details  of  these  phenomena  are  highly  complex, 
some  of  them  obscure;  an  imm.ense  literature  has 
already  been  devoted  to  the  subject,  yet  its  systematic 
study  is  hardly  more  than  begun.  The  account  given 
in  the  preceding  paragraph  is  incomplete  and  meagre. 
It  is  inserted  here  in  the  hope  that  it  will  impress  the 
reader  with  a  sense  both  of  the  fact  of  these  alternations 
and  of  the  deeply  rooted  nature  of  the  causes  from  which 
they  spring.    They  take  a  heavy  toll  of  human  happi- 


36  SUPPLY  AND  DEMAND 

ness  and  wealth;  and  there  is  no  object  that  more 
urgently  calls  for  concerted  human  effort  than  that  of 
mitigating  them,  and  of  alleviating  the  misery  which 
they  bring  in.  their  train.  Still  better,  of  eradicating 
them  if  that  is  possible;  but  let  none  suppose  that  it  can 
be  lightly  done.  Meanwhile,  let  us  always  remember 
that  they  form  the  atmosphere  and  medimn  in  which 
the  enduring  tendencies  of  the  business  world  must 
work  themselves  out.  It  is  often  convenient  to  speak  of 
"normal  conditions"  in  this  trade  or  that;  but  hardly 
ever  can  it  be  truly  said  of  a  particular  moment  that 
conditions  are  normal.  The  normal  is  rather  a  mean 
level  about  which  oscillations  to  and  fro,  round  and 
about,  are  constantly  taking  place,  but  which  itself  is 
reached  only  by  accident,  if  at  all.  Whenever  we  say 
that  some  new  factor  should  in  the  long  run  lower 
the  price  of  this  or  that  commodity  or  service,  the 
picture  which  these  words  should  convey  to  our  mind 
is  one  of  the  price  rising  less  on  times  of  boom,  and 
falling  more  in  tim.es  of  depression  than  is  the  case 
with  other  things.  And  if  ever  our  faith  in  some 
honored  economic  law  is  shaken  by  the  apparent  ease 
with  which,  perhaps,  in  times  of  active  trade,  sellers  are 
able  to  advance  their  prices  to  whatever  figure  (so  it 
almost  seems)  they  choose  to  name,  let  us  rally  our 
sense  of  economic  rhythm,  and  reserve  our  judgment 
until  the  trade  cycle  has  run  its  course. 


CHAPTER  III 

UTILITY    AND    THE   MARGIN    OF 
CONSUMPTION 

§  1.  The  Forces  behind  Supply  and  Demand.  The 
laws  enunciated  in  the  preceding  chapter  constitute 
the  framework  and  skeleton  of  all  economic  analysis; 
but  they  do  not  carry  us  very  far.  It  is  only  through 
the  agency  of  these  laws  that  any  influence  can  affect 
the  price  of  anything:  but  what  influences  may  so 
affect  it  is  a  question  which  we  have  still  to  consider. 

Let  us  begin  with  ordinary  connnodities  and  ask  our- 
selves, in  the  light  of  experience  and  cormnon  sense, 
upon  what  factors  their  price  seems  mainly  to  depend? 
Two  factors  spring  to  mind  at  once;  their  cost  of  pro- 
duction and  their  usefulness.  As  regards  the  former,  the 
case  seems  clear  enough.  We  may  indeed  sometimes 
grumble  that  the  price  of  this  or  that  commodity  is 
unconscionably  high  in  comparison  with  its  cost;  but 
this  only  goes  to  show  that  we  conceive  a  relation  be- 
tween price  and  cost  as  the  normal,  governing  rule.  If 
one  commodity  cost  only  a  half  as  much  to  produce  as 
another,  we  should  think  that  something  had  gone  very 
wrong  indeed,  if  the  former  commodity  were  sold  for 
the  higher  price.  But,  when  we  turn  to  the  usefulness 
of  commodities,  the  case  is  not  so  clear.  Usefulness  has 
some  connection  with  price,  so  much  is  certain;  for  an 
entirely  useless  thing,  fit  only  for  the  dust-bin  (and 

37 


38  SUPPLY  AND  DEMAND 

known  to  be  such,  it  may  be  well  to  add)  will  fetch  no 
price  at  all,  however  costly  it  may  be  to  produce.  But 
it  is  not  easy  to  express  the  connection  in  quantitative 
terms.  It  seems  reasonable  enough  to  say  that  the 
prices  of  commodities  are  roughly  proportionate  to 
their  costs  of  production.  But  directly  we  contemplate 
saying  a  similar  thing  of  their  usefulness,  we  are  pulled 
up  short.  As  we  look  round  the  world,  and  enumerate 
the  corranodities  which  by  common  consent  are  the 
most  useful,  salt,  water,  bread,  and  so  forth,  the  strik- 
ing paradox  presents  itself  that  these  are  among  the 
cheapest  of  all  commodities;  far  cheaper  than  cham- 
pagne, motor-cars  or  ball-dresses,  which  we  could  very 
well  get  on  without.  As  things  are,  of  course,  a  ball- 
dress,  or  a  motor-car  costs  more  to  produce  than  a  loaf 
of  bread  or  a  packet  of  salt;  and  the  common-sense 
explanation  of  the  paradox  seems,  therefore,  to  be  that 
the  cost  of  production  is  a  more  weighty  influence 
than  the  usefulness,  or  utility,  as  we  will  henceforth  call 
it  (so  as  to  include  the  satisfaction  we  derive  from  not 
strictly  useful  things).  We  are  thus  tempted  to  con- 
clude that,  provided  a  comimodity  possesses  some  utility, 
its  price  will  be  determined  by  the  cost  of  production, 
the  degree  of  utility  being  unimportant.  This  was  ex- 
actly how  the  position  was  summed  up  for  many  years 
in  systematic  treatises  upon  Political  Economy;  and 
it  was  not  until  fully  half  a  century  after  the  Wealth 
of  Nations  that  a  discovery  was  made  which  threw  a 
fresh  light  on  the  whole  matter. 

First  of  all,  let  it  be  clearly  observed  how  very 
unsatisfactory  is  the  above  account.  In  Chapter  II 
where  we  were  treading  surely,  with  a  sense  of  soUd 


UTILITY  39 

ground  beneath  us,  we  drew  no  such  invidious  dis- 
tinction between  supply  and  demand.  They  seemed 
then  to  possess  an  equal  status.  But  cost  of  production 
is  the  chief  factor  which,  in  the  case  of  commodities, 
ultimately  determines  the  conditions  of  supply.  Util- 
ity, similarly,  is  the  chief  factor  which  ultimately  de- 
termines the  conditions  of  demand.  Must  not  then  the 
symmetrical  relations  between  demand  and  supply  be 
reflected  in  a  corresponding  symmetiy  between  the 
utility  and  the  costs  which  underlie  them?  Demand 
springs  obviously  from  utility;  the  only  motive  for 
buying  anything  is  that  it  will  serve  some  real  or  fancied 
use.  Can  we  then  accord  to  demand  so  dignified  and 
to  utility  so  subordinate  a  place?  There  is  here  an 
inconsistency  which  we  must  somehow  reconcile.  It 
will  not  serve  as  a  solution  to  distinguish  between 
different  periods  of  time,  and  to  say,  as  economists  used 
to  say  not  very  long  ago,  that  price  is  governed  over  a 
short  period  by  demand  and  supply,  but  in  the  long  run 
by  the  cost  of  production.  This  still  leaves  our  sense  of 
symmetry  unsatisfied.  Moreover,  the  conception  of 
cost  of  production,  when  we  consider  it  as  ruling  over 
a  long  period,  frequently  seems  to  lose  any  precision, 
as  an  independent  factor,  which  it  may  otherwise 
possess.  Motor-cars,  we  have  agreed,  are  more  costly 
to  produce  than  loaves  of  bread;  but,  as  we  know  well, 
the  cost  of  producing  motor-cars  varies  enormously, 
accordingly  as  they  are  produced  on  a  small  or  a  large 
scale.  By  the  methods  of  mass  production  they  can  be 
turned  out  at  a  relatively  low  cost  per  car.  But  this 
requires  that  they  should  be  purchased  in  large  numbers 
and  this  in  turn  throws  us  back  to  the  demand  for 


40  SUPPLY  AND  DEMAND 

motor-cars,  and  plainly  enough,  to  people's  judgment 
as  to  their  utility.  In  some  cases,  the  opposite  phe- 
nomenon occurs.  In  the  case  of  British  coal,  for  in- 
stance, the  average  cost  of  production  would  be  much 
lower  than  it  is  if  the  output  were  reduced  to  a  fraction 
of  its  present  volume,  and  if  only  the  richer  seams  of  the 
more  fertile  mines  were  worked.  Once  again,  therefore 
it  is  difficult  to  measure  the  cost  of  production  until  we 
know  the  magnitude  of  the  demand,  which  in  a  manner, 
which  we  have  still  to  elucidate,  clearly  depends  upon 
the  utility. 

If  we  take  the  problem  of  joint  products,  the  con- 
ception of  cost  of  production  fails  us  still  more  con- 
spicuously. For  what  is  the  cost  of  producing  wool, 
or  the  cost  of  producing  mutton?  We  can  speak  of 
the  cost  of  rearing  sheep:  but  it  is  hardly  possible 
to  allot  this  cost,  except  quite  arbitrarily,  between 
the  two  products.  How,  then,  can  we  explain  the 
separate  prices  of  these  things  by  reference  to  cost 
alone?  Instances  of  joint  production  are  becoming  so 
common  in  the  modern  world,  or  at  least,  with  the 
growing  attention  to  the  utilization  of  by-products,  are 
assuming  so  much  more  heightened  a  significance,  that 
an  explanation  of  price,  which  does  not  apply  to  them, 
is  a  very  feeble  one  indeed. 

§  2.  The  Law  of  Diminishing  Utility.  Let  us  turn 
back,  then,  to  the  factor  of  utility,  and  see  if  we  cannot 
put  on  a  more  satisfactory  basis  the  relation  between 
utility  and  price.  The  clue  to  the  puzzle  is  to  be  found 
in  a  brief  reflection  on  the  implications  of  the  second 
general  law  propounded  in  Chapter  II.    A  rise  in  price, 


UTILITY  41 

it  was  there  stated,  will  sooner  or  later  diminish  the 
demand.  This  was  asserted  as  a  matter  of  fact,  ob- 
served from  and  confirmed  by  experience.  But  what 
does  it  signify?  To  what  causes  is  this  familiar  fact 
to  be  attributed?  The  first  stage  of  the  answer  is  very 
simple.  The  many  individuals,  whose  purchases  make 
up  the  demand  for  the  commodity,  will  buy  smaller 
quantities  now  that  the  price  is  higher.  Possibly  some 
of  them  may  cease  to  buy  it  altogether;  but  as  a  rule 
it  would  be  reasonable  to  suppose  that  most  people  con- 
tinue to  buy  a  certain  amount  though  a  smaller  amount 
than  hitherto.  Let  us  turn  our  attention,  then,  to  the 
individual  purchaser,  and  ask  ourselves  why  he  (or  let 
us  say  she)  acts  in  the  manner  indicated.  The  obvious 
answer  is  that  the  more  she  already  has  of  anything, 
the  less  urgently  does  she  require  a  little  more  of  it. 
If  she  buys  6  pounds  of  sugar  every  week  when  the  price 
is  7  cents  a  pound,  but  only  5  pounds  when  the  price  is  8 
cents,  she  shows  by  her  action  that  she  does  not  consider 
that  the  additional  utility  she  will  derive  from  buying  6 
pounds  a  week  rather  then  5  pounds  is  worth  as  much  as 
8  cents.  But  she  shows  at  the  same  time  that  she  thinks 
it  worth  7  cents.  For,  when  the  price  is  7  cents,  no  one 
compels  her  to  buy  that  sixth  pound.  She  could  stop,  if 
she  chose,  at  five;  and  it  may  serve  to  make  the  point 
quite  plain  if  we  suppose  her  actually  to  hesitate  before 
she  buys  the  sixth.  She  has  hitherto,  let  us  say,  been 
buying  5  pounds  a  week  at  8  cents.  To-day  she  enters 
the  shop  and  finds  the  price  is  down  to  7  cents.  She 
asks  for  her  customary  5  pounds;  then  she  pauses,  and  a 
minute  later  turns  her  order  into  six.  What  are  the  al- 
ternatives which  she  has  been  weighing  one  against  the 


42  SUPPLY  AND  DEMAND 

other  in  that  momentary  pause?  Not  the  utihty  of  the 
whole  6  pounds  of  sugar  against  the  total  price  of  42 
cents.  For  she  has  already  ordered  the  first  5  pounds; 
and  the  decision  to  buy  the  sixth  is  taken  independently 
and  subsequently.  She  has  been  sizing  up  the  increment 
of  utility  which  a  sixth  pound  would  yield,  and  she  de- 
cides that  this  is  worth  the  expenditure  of  a  further  7 
cents.  Again,  when  the  price  was  8  cents  she  need  not 
have  bought  as  many  as  5  pounds.  She  could  have 
stopped  at  4  had  she  chosen,  and  the  fact  that  she  did 
buy  5  pounds  shows  that  the  increment  of  utility  de- 
rived from  buying  a  fifth  pound,  when  she  might  be  said 
already  to  have  4,  was  worth  at  least  8  cents  in  her 
judgment. 

This  trite  illustration  enables  us  to  lay  down  two 
important  laws  relating  to  utility.  To  state  them 
shortly,  it  is  convenient  to  employ  one  or  two  technical 
terms,  which,  unlike  every  term  emploj^ed  hitherto, 
are  not  very  commonly  used  in  their  present  sense  in 
everj^day  life.  Their  adoption  is  desirable  not  merely 
for  the  sake  of  convenience,  but  because  they  help 
to  stamp  clearly  on  the  mind  a  most  illuminating 
conception,  that  of  the  "margin,"  which  supplies 
the  clue  to  many  complicated  problems.  The  last 
pound  of  sugar  which  the  housewife  purchased,  the 
fifth  pound  when  the  price  was  8  cents,  or  the  sixth 
pound  when  the  price  was  7  cents,  we  call  the  "mar- 
ginal" pound  of  sugar.  And  the  increment  of  utility 
which  she  derives  from  buying  this  marginal  pound 
we  call  the  "marginal  utility"  of  sugar  to  her.  We 
are  thus  able  to  state  the  fact  that  the  more  a 
person  has   of   anything  the   less   urgently   does   he 


UTILITY  43 

require  a  little  more  of  it,  in  the  following  formal 
terms: — 

V.    The  marginal  utility  of  a  commodity  to  anyone 

diminishes  with  every  increase  in  the  amount 

he  has. 

The  total  utility  will,  of  course,  increase  with  an  in- 
crease in  the  amount,  but  at  a  diminishing  rate.  This 
law  is  usually  called  The  Law  of  Diminishing  Utility. 

§  3.  Relation  between  Price  and  Marginal  Utility 
But  this  is  not  all.  We  are  now  in  a  position  to  per- 
ceive the  true  relation  between  utility  and  price.  The 
relation  is  one  which  exists  not  between  price  and  total 
utility,  but  between  price  and  marginal  utility.  If  we 
know  only  that  a  housewife  will  buy  weekly  5  pounds  of 
sugar  at  8  cents  per  pound,  but  6  pounds  at  7  cents,  we 
know  nothing  of  the  total  utility  of  sugar  to  her.  We  do 
not  know  how  much  she  might  be  prepared  to  pay 
rather  than  go  without  3  pounds,  2  pounds,  or  any  sugar 
at  all.  But  we  do  Icnow  that,  when  she  buys  6  pounds, 
the  marginal  utility  of  sugar  is  in  her  judgment  worth 
something  which  does  not  differ  greatly  from  the  price. 
We  can,  therefore,  say  in  general  terms  that  the  price  of 
a  commodity  measures  approximately  its  marginal 
utility  to  the  purchaser. 

This  statement  is  perfectly  consistent  with  the 
paradox  noted  above  that  the  most  useful  commodities 
such  as  bread,  salt  and  water  are  very  cheap.  For 
when  we  say  that  these  commodities  are  supremely 
useful,  we  mean  only  that  their  total  utility  is  very 
great;  that,  rather  than  do  without  them  altogether, 
we  would  offer  for  them  a  large  proportion  of  our  means. 


44  SUPPLY  AND  DEMAND 

But  we  would  not  value  very  highly  a  small  addition 
to  the  bread,  water  or  salt  that  we  habitually  consume; 
nor  would  most  of  us  feel  it  as  a  very  serious  depriva- 
tion if  our  consumption  of  these  things  were  curtailed 
by  a  small  percentage.  In  other  words,  their  marginal 
utilities  are  small,  and  it  is  only  the  marginal  utility 
that  has  any  relation  to  price. 

§  4.  The  Marginal  Purchaser.  A  possible  objection 
to  the  preceding  argument  deserves  to  be  considered. 
Some  readers  may  find  the  picture  I  have  drawn  of 
the  hesitating  housewife  entirely  unconvincing.  They 
may  declare  that  her  mind  does  not  work  at  all  in 
the  manner  I  have  indicated.  She  will  have  formed 
certain  habits  in  regard  to  her  weekly  purchases  of 
sugar,  which  are  connected  very  vaguely,  if  at  all,  with 
any  conscious  processes  of  thought.  She  will  buy  so 
many  pounds  of  sugar  weekly  without  troubling  her 
head  over  the  specific  utility  of  the  last  pound  she  buys. 
When  the  price  falls  she  may,  indeed,  buy  more;  but 
it  will  not  be  because  she  separates  out  and  considers 
by  itself  the  extra  utility  of  an  additional  pound.  She 
may  buy  more,  because  she  has  formed  the  habit  of 
spending  so  much  money  on  sugar;  and  now  that  the 
price  has  fallen,  the  same  amount  of  money  will  enable 
her  to  buy  more  pounds.  Or,  perhaps,  she  may  be 
moved  by  instinctive  and  irresistible  attraction  to  buy 
more  of  a  thing  when  it  is  cheaper,  similar  to  that  which 
inspires  so  many  people  to  face  with  ardor  the  horrors 
of  a  bargain  sale.  In  any  case  the  fine  calculations  I 
have  imagined  convey  a  fantastic  picture  of  her  state  of 
mind.    And  how  much  more  fantastic,  the  critic  mav 


UTILITY  45 

continue,  of  the  state  of  mind  in  which  things  of  a 
different  kind  are  bought  by  less  careful  people.  When, 
for  instance,  one  of  us  happy-go-lucky  males  (more 
liberally  supplied,  perhaps,  than  the  housewife  with  the 
necessary  cash),  decides  to  buy  a  motor  bicycle,  or  to 
replenish  his  stock  of  collars  or  ties,  does  the  above 
analysis  bear  any  resemblance  to  the  actual  facts?  In 
the  case  of  the  motor  bicycle,  the  purchaser  may,  in- 
deed, weigh  the  price  fairly  carefully  against  the  pleas- 
ure and  benefit,  though  contrariwise  he  may  be  a  rich 
enough  gentleman  hardly  to  bother  about  this.  But, 
one  motor  bicycle  is  as  much  as  he  is  at  all  likely  to  buy, 
and  what  becomes,  then,  of  the  distinction  between 
total  and  marginal  utility?  In  the  case  of  the  ties  and 
collars,  the  vagueness  of  many  of  us  about  the  price  will 
be  extreme.  We  probably  have  been  uneasilj''  conscious 
for  some  time  of  an  inconvenient  shortage  of  these 
troublesome  articles  and  eventually  will  go  off  (or 
perhaps  will  be  sent  off  with  ignominy)  to  the  nearest 
suitable  shop  to  make  good  the  deficiency.  How  can 
we  speak  here  with  a  straight  face  of  the  relation  be- 
tween marginal  utility  and  price? 

These  are  very  pertinent  criticisms;  but  they  do 
not  make  nearly  as  much  nonsense  of  the  notion  of 
marginal  utility  as  may  seem  at  first.  The  last  point, 
indeed,  serves  rather  to  give  it  a  fresh  aspect  of  much 
significance.  Those  of  us  who  do  not  bother  about  the 
price  we  pay  for  our  ties  and  collars  owe  a  debt  of  grati- 
tude, of  which  we  are  insuflSciently  conscious,  to  the 
more  careful  people  who  do;  as  well  as  to  the  custom 
which  prevails  in  shops  in  Western  countries  (as  dis- 
tinct from  the  bazaars  of  the  East)  of  charging  as  a 


46  SUPPLY  AND  DEMAND 

rule  a  uniform  price  to  all  customers.  If  we  were  the 
only  people  who  bought  these  things,  an  enterprising 
salesman  would  be  able  to  charge  us  very  much  what 
he  chose.  He  could  put  up  his  price,  and  we  would 
hardly  be  aware  of  it.  And,  as  by  lowering  his  price  he 
could  not  tempt  us  to  buy  any  more,  price  reductions 
would  be  few  and  far  between.  But  fortunately  there 
are  always  some  people  who  do  know  what  the  price 
is,  even  when  they  are  buying  collars  and  ties;  and  who 
will  adjust  the  amount  they  buy  in  accordance  with  the 
price.  It  is  these  worthy  people  who  make  the  laws 
of  demand  work  out  as  we  well  know  they  do.  It  is 
they  who  will  curtail  their  consumption  if  the  price  has 
fallen  and  it  is  they  who  constitute  the  seller's  problem, 
and  help  to  keep  down  prices  for  the  rest  of  us.  The 
rest  of  us — it  is  well  to  be  quite  blunt  about  it — simply 
do  not  count  in  this  connection.  A¥e  have  no  cause 
then  to  plume  ourselves  that  we  have  disproved  the 
truth  of  economic  laws  when  we  declare  that  we  seldom 
weigh  the  utility  of  anything  against  its  price.  All 
that  this  shows  is  that  our  actions  are  too  insignificant 
to  be  described  by  economic  laws  since  they  exert  no 
appreciable  influence  on  the  price  of  anything.  And 
this  in  turn  shows  the  extreme  importance  of  grasping 
clearly  the  conception  of  the  margin.  Just  as  it  is 
the  marginal  purchase,  so  it  is  the  marginal  purchaser 
who  matters.  It  is  the  man  who,  before  he  buys  a 
motor  bicycle,  weighs  the  matter  up  very  carefully 
indeed  and  only  just  decides  to  buy  it,  whose  demand 
affects  the  price  of  motor  bicycles.  It  is  the  utility 
which  he  derives  that  constitutes  the  marginal  utility, 
which  is  roughly  measured  by  the  price. 


UTILITY  47 

As  to  the  housewife,  I  am  not  prepared  to  concede 
that  my  picture  is  in  essentials  very  fanciful.  She  may 
be  a  creature  of  habits  and  instincts  like  the  rest  of 
us,  but  most  habits  and  instincts  affecting  household 
expenditure  are  based  ultimately  on  some  calculation, 
if  not  one's  own,  and  reason  has  a  way  of  pajdng,  as 
it  were,  periodic  visits  of  inspection,  and  pulling  our 
habits  and  instincts  into  line,  if  they  have  gone  far 
astray.  I  am  not  satisfied  that  the  housewife  does  not 
envisage  the  utility  of  a  sixth  pound  of  sugar  as  some- 
thing distinct  from  the  utility  of  the  other  five;  she 
may  buy  it,  for  example,  with  the  definite  object  of 
giving  the  children  some  sugar  on  their  bread,  and  she 
may  have  a  very  clear  idea  as  to  the  price  v/hich  sugar 
must  not  exceed  before  she  wHl  do  any  such  thing. 
Possibly  I  may  exaggerate.  I  have  the  profound 
respect  of  the  incorrigibly  wasteful  male  for  the  care 
and  skill  she  displays  in  laying  out  her  money  to  the 
best  advantage. 

§  5.  The  Business  Man  as  Purchaser.  But  if  the  reader 
still  finds  the  picture  unconvincing,  let  us  shift  the 
scene  from  domestic  economy  to  commerce,  and  sub- 
stitute for  the  careful  housewife  an  enterprising  busLuess 
man.  Now,  as  anyone  who  has  a  business  man  for  his 
father  will  have  often  heard  him  say,  the  vagueness  and 
caprice  which  characterize  our  personal  expenditure 
would  be  quite  intolerable  in  business  affairs.  There 
you  must  weigh  and  measure  with  the  utmost  possible 
precision.  You  must  be  for  ever  watching  the  several 
channels  of  your  expenditure,  careful  to  see  that  in 
none  does  the  stream  rise  higher  than  the  level  at  which 


48  SUPPLY  AND  DEMAND 

further  expenditure  ceases  to  be  profitable.  You  will 
not  even  engage  typists  or  install  a  telephone  in  your 
office  without  weighing  up  fairly  carefully  the  number 
of  typists  or  the  number  of  switches  that  it  is  worth 
your  while  to  have.  And  in  deciding  whether  to  employ 
say,  five  typists,  or  sLx,  you  will  not  vaguely  lump  the 
services  of  the  whole  six  typists  together,  and  consider 
whether  as  a  whole  they  are  worth  to  you  the  wages 
you  must  give  them.  You  will,  in  the  most  direct  and 
literal  manner,  weigh  up  the  additional  benefit  you 
would  derive  from  a  sixth  typist,  and  if  that  does  not 
seem  to  you  equivalent  to  her  wage,  you  will  not  engage 
her,  however  essential  it  may  be  to  you  to  have  one  or 
two  typists  in  your  office.  If  on  the  other  hand,  the 
utility  of  having  a  sLxth  typist  seems  to  you  worth 
much  more  than  her  pay,  the  chances  are  that  you  will 
be  well  advised  to  consider  the  employment  of  a  seventh. 
And  so,  where  you  stop  emploj'ing  further  typists, 
the  utility  to  you  of  the  last  one,  of  the  "marginal 
typist"  as  it  were,  is  unlikely  to  differ  greatly  from  her 
pay. 

Now  this  is  not  a  fancy  picture  of  some  remote 
abstraction  called  an  "economic  man."  Allowing  for 
the  over-emphasis  which  is  necessary  to  drive  home  the 
central  point,  it  is  a  bald  account  of  the  aims  and 
methods  of  the  actual  man  of  business.  To  ascertain 
the  margin  of  profitable  expenditure  in  each  direction, 
to  go  thus  and  no  further,  is  the  very  essence  of  the 
business  spirit,  as  the  business  man  himself  conceives 
it.  When  he  condemns  the  extravagance  of  Govern- 
ment departments,  it  is  their  lack  of  just  this  marginal 
sense  that  he  chiefly  has  in  mind.    "The  lore  of  nicely 


UTILITY  49 

calculated  less  or  more"  may  be  rejected  by  High 
Heaven  and  Whitehall,  but  no  one  can  afford  to  despise 
it  in  the  business  world. 

The  transition  from  household  to  business  expendi- 
ture involves  an  extended  use  of  the  word  utility,  which 
is  worth  noting.  Commodities  like  bread,  sugar,  or 
privately  owned  motor-cars  are  sometimes  called 
"consumers'  goods"  in  contrast  to  "producers'  goods," 
which  comprise  things  such  as  raw  materials,  machin- 
ery, the  services  of  typists  and  so  forth,  which  are 
bought  by  businees  men  for  business  purposes.  The 
line  of  division  between  the  two  classes  is  not  a  sharp 
one,  and  we  need  not  trouble  with  fine-spun  questions 
as  to  whether  a  particular  commodity  should  in  certain 
circumstances  be  included  under  the  one  head  or  the 
other.  But,  broadly  speaking,  things  of  the  former 
type  yield  a  direct  utility;  they  contribute  directly  to 
the  satisfaction  of  our  pleasures  or  our  wants.  Things 
of  the  latter  type  yield  rather  an  indirect  utility.  Their 
utility  to  the  business  man  who  buys  them  lies  in  the 
assistance  they  give  him  in  making  something  else  from 
which  he  will  derive  a  profit.  The  utility  of  these 
things  is  therefore  said  to  be  derived  from  that  of  the 
consumers'  goods  or  services  to  which  they  ultimately 
contribute.  This  conception  of  derived  utility  leads  to 
certain  comphcations  which  we  shall  have  to  notice 
later. 

§  6.  The  Diminishing  Utility  of  Money.  But  one 
important  point  must  be  emphasized  in  this  chapter. 
The  utility  which  a  business  man  derives  from  the 
things  which  he  buys  for  business  purposes  is  the  extra 


50  SUPPLY  AND  DEMAND 

receipts  which  he  obtains  thereby.  Derived  utility, 
in  other  words,  is  expressed  in  terms  of  mone}^,  and  the 
idea  of  its  relation  to  price  presents  no  difficulty.  But 
the  utilitj''  of  things  which  are  bought  for  personal 
consumption  means  the  satisfactio7i  which  they  yield, 
and  this  is  clearly  not  a  thing  which  is  commensurable 
with  money.  When,  therefore,  it  is  said  that  the  prices 
measure  their  respective  marginal  utilities,  what  exactly 
is  meant?  What  was  it  that  the  argument  of  §  3  went 
to  show?  That  the  utility  of  the  mi.arginal  pound  of 
sugar  would  seem  to  the  housewife  just  worth  the  price 
that  she  must  pay  for  it;  in  other  words,  that  it  would 
be  roughly  equal  to  the  utility  she  could  obtain  by 
spending  the  money  in  other  ways.  The  respective 
marginal  utilities  which  she  obtains  from  the  different 
thmgs  she  buys  will  thus  be  proportionate  to  their 
prices.  But  if  she  were  to  receive  a  legacy  which  gave 
her  a  much  larger  income  to  spend,  she  might  buy 
larger  quantities  of  practically  every  commodity;  and, 
though  she  would  obtain  a  greater  total  utility  thereby, 
the  marginal  utility  she  would  obtain  in  each  direction 
would  be  sm.aller,  in  accordance  with  the  law  of  dimin- 
ishing utility.  The  prices  might  not  have  changed; 
the  respective  marginal  utilities  to  her  of  the  different 
things  would  again  be  proportionate  to  their  prices, 
but  they  would  constitute  a  smaller  satisfaction  than 
before. 

Thus  we  can  only  say  that  the  prices  of  commodities 
will  be  proportionate  to  their  real  marginal  utilities, 
when  we  are  considering  the  different  purchases  of 
one  and  the  same  individual.  The  amounts  of  monej' 
which  different  people  are  prepared  to  pay  for  dif- 


UTILITY  51 

ferent  consumers'  goods  are  no  reliable  indication 
of  the  real  utilities,  the  amounts  of  hmnan  satisfaction 
which  they  yield.  Here  we  must  take  account  not 
only  of  varying  needs  and  capacities  for  enjoyment, 
but  of  the  very  unequal  manner  in  which  purchasing 
power  is  distributed  among  the  people.  The  cigars 
which  a  rich  man  may  buy  will  yield  him  an  immeasur- 
ably smaller  satisfaction  than  that  which  a  poor  family 
could  obtain  by  spending  the  same  amount  of  money 
on  boots,  or  clothes  or  milk.  When,  therefore,  we 
compare  conmiodities  which  are  bought  by  essentially 
different  consuming  publics,  their  respective  prices  may 
bear  no  close  relation  to  their  real  utility,  whether 
marginal  or  otherwise.  Thus  the  law  of  diminishing 
utility  applies  to  money  or  purchasing  power,  as  well 
as  to  particular  commodities.  The  more  money  a 
man  has  the  less  is  the  marginal  utility  which  it  yields 
him;  and,  where  the  marginal  utility  of  money  to  a 
man  is  small,  so  also  will  be  the  real  marginal  utility 
he  derives  in  each  direction  of  his  expenditure.  The 
extreme  inequality  of  the  distribution  of  wealth  gives 
immense  importance  to  this  consideration.  Its  practical 
implications  will  be  discussed  in  Chapter  V.  Mean- 
while, we  may  express  the  conclusions  of  the  present 
chapter  by  the  statement  that  the  price  of  a  commodity 
tends  to  equal  its  marginal  utility,  as  measured  in  terrns 
of  money,  i.  e.  relatively  to  the  marginal  utility  of  money 
to  its  purchaser. 


CHAPTER  IV 

COST  AND  THE  MARGIN  OF  PRODUCTION 

§  1.  An  Illustration  from  Coal,  We  have  already 
had  occasion  to  note  the  symmetry  which  characterizes 
the  relations  of  demand  and  supply  to  price.  This 
symmetry  was  apparent  throughout  the  argument 
of  Chapter  II,  and  it  was  a  striking  feature  of  the 
diagrams  which  we  employed  to  illustrate  the  argument. 
We  shall  do  well  to  cultivate  a  lively  sense  of  this 
symmetry,  for  it  will  frequently  save  us  from  ignoring 
factors  which  have  a  vital  bearing  on  the  problems 
we  are  considering.  We  should  never  leave  an  impor- 
tant feature  of  demand  without  turning  to  see  whether 
it  has  a  counterpart  on  the  supply  side,  though  indeed 
we  may  not  alv/ays  find  one.  In  the  last  chapter  we 
examined  the  relation  between  utility  and  price,  and 
found  that  the  true  relation  was  between  the  price  and 
what  we  termed  the  marginal  utility.  Corresponding 
to  utility  on  the  demand  side  is  cost  of  production 
on  the  supply  side.  The  question  should  thus  at  once 
suggest  itself — "Can  we  speak  appropriately  of  the 
marginal  cost  of  production,  and  will  this  serve  to 
make  clear  the  relation  between  cost  and  price?"  To 
answer  these  questions,  let  us  take  one  of  the  in- 
stances in  which  we  found  that  price  could  not  be 
explained  satisfactorily  by  the  bare  phrase  ''cost  of 

production." 

52 


COST  AND  THE  MARGIN  OF  PRODUCTION     53 

An  important  feature  of  the  coal  industry,  which 
recent  events  have  brought  into  sharp  prominence, 
is  the  great  diversity  of  conditions  between  different 
coalfields  and  dijEferent  collieries.  We  speak  of  rich 
seams  and  poor  seams,  of  fertile  and  unfertile  mines, 
and  we  are  aware  that  the  costs  of  raising  coal  to  the 
surface  differ  very  widely  in  accordance  with  these 
diverse  natural  conditions.  Nor  must  we  confine  our 
attention  to  the  cost  price  at  the  pit-head.  If  we  wish 
to  speak  of  cost  of  production  as  a  factor  determining 
price,  we  must  use  the  term  in  a  broad  sense  to  include 
the  transport  and  other  charges  necessary  to  bring 
the  coal  to  market. 

In  this  respect  also  one  coalfield  differs  greatly  from 
another.  Some  are  well  situated  close  to  a  large  market, 
or  within  easy  reach  of  the  seaboard;  others  must 
incur  very  heavy  transport  charges  to  bring  their  coal 
to  any  considerable  centre  of  consumption.  These 
varying  conditions  lead,  as  we  well  know,  to  great 
variations  in  the  financial  prosperity  of  different  colliery 
concerns.  In  Great  Britain,  under  the  abnormal 
conditions  which  prevailed  during  the  war,  and  sub- 
sequently, these  variations  were  so  huge  as  to  constitute 
a  most  formidable  embarrassment  and  to  contribute, 
more  perhaps  than  any  other  single  factor,  to  the 
unrest  and  instability  by  which  the  industry  has  been 
afiiicted.  But  they  are  always  with  us,  if  usually  upon 
a  more  modest  scale. 

What,  then,  is  the  normal  relation  between  price  and 
cost  in  the  case  of  coal?  Should  we  direct  our  attention 
to  the  average  costs  over  the  whole  industry,  or  the 
costs  incurred  by  the  richer  and  better  situated  mines, 


54  SUPPLY  AND  DEMAND 

or,  lastly,  that  of  the  poorer  and  worse  situated? 
Now,  as  things  are,  it  is  clear  enough  that  no  concern 
will  continue  indefinitely  producing  at  a  loss.  It  may 
do  so  for  a  time,  rather  than  close  down  altogether, 
hoping  to  recoup  itself  later  when  the  market  has 
taken  a  more  favorable  turn.  But,  in  the  long  run, 
taking  good  years  with  bad,  it  must  expect  to  obtain 
receipts  sufficient  not  only  to  cover  its  necessary 
expenditure,  but  to  provide  also  a  reasonable  profit 
on  the  capital  employed.  Of  course,  once  the  capital 
has  been  sunk  and  embodied  in  plant  and  buildings, 
which  are  of  little  use  for  any  other  purpose,  a  business 
may  continue  for  many  years,  with  a  rate  of  profit 
far  below  what  it  had  anticipated.  But  plant  and 
buildings  gradually  wear  out,  and  need  to  be  replaced; 
the  course  of  technical  improvement  calls  continually 
for  fresh  capital  outlay,  which  a  business  in  a  bad  way 
is  reluctant  to  undertake.  The  tendency,  therefore, 
when  profits  rule  low  over  a  considerable  period,  is 
for  the  plant  to  fall  gradually  into  disrepair  and 
obsolescence,  and  finally  for  the  business  to  disappear. 
We  can  thus  include  an  ordinary  rate  of  profit  under  the 
head  of  cost  of  production,  and  say  with  substantial 
accuracy  that  for  no  business  can  this  cost  for  long 
exceed  the  price  if  the  business  is  to  continue  to  exist. 
If  then  the  relatively  poor  and  badly  situated  mines 
are  to  be  worked,  the  price  of  coal,  taking  good  years 
together  with  bad,  must  cover  the  costs  at  which  these 
mines  can  produce.  If  the  price  rules  lower  than  this, 
sooner  or  later  they  will  close  down,  and  we  will  be  left 
with  a  smaller  number  of  mines,  among  which  great 
variations  of  conditions  will  still  prevail.    Once  more, 


COST  AND  THE  MARGIN  OF  PRODUCTION    55 

the  price  must  cover  the  cost  incurred  by  the  least 
profitable  of  these  remaining  mines,  unless  their  number 
is  still  further  to  be  diminished.  Thus  we  can  conceive 
of  a  "margin  of  production"  which  will  shift  backwards 
to  more  profitable  or  forwards  to  include  less  profitable 
mines,  according  as  the  demand  for  coal  contracts 
or  expands.  But,  wherever  this  margin  maj'^  be,  there 
is  no  escaping  the  conclusion  that  it  is  the  cost  of 
production  of  the  "marginal  mines,"  of  those  that  is 
to  say  which  it  is  only  just  worth  while  to  work,  to 
which  the  price  of  coal  will  approximate. 

It  follows  that  there  is  no  real  connection  between 
price  and  cost  of  production  throughout  the  industry 
as  a  whole.  It  follows  incidentally  that  those  concerns 
which  can  market  their  coal  at  an  appreciably  lower 
cost  than  the  marginal  concerns,  are  likely  to  reap 
more  than  an  ordinary  rate  of  profit,  though  royalties 
may  absorb  part  of  the  excess. 

§  2.  The  Various  Aspects  of  Marginal  Cost.  This 
relation  cuts  much  deeper  than  the  particular  system 
under  which  the  mines  are  at  present  owned  and  worked. 
If,  for  instance,  we  supposed  that  the  various  mines 
were  amalgamated  together  in  a  few  giant  concerns, 
each  of  which  comprised  some  of  the  richer  and  some 
of  the  poorer  mines,  the  preceding  argument  would 
need  to  be  recast  in  form,  but  its  substance  would  be 
unaffected.  For  though  a  great  coal  trust  could  in  a 
sense  afford  to  sell  at  a  price  lower  than  the  marginal 
cost,  setting  its  losses  on  the  poorer  against  its  gains 
on  the  better  pits,  is  it  likely  it  would  do  so?  Why 
should  it  dissipate  its  profits  in  this  way?    It  is  clearly 


56  SUPPLY  AND  DEMAND 

more  reasonable  to  suppose  that  it  would  close  down 
the  poorer  pits  (unless  it  could  advance  the  price  of 
coal) ,  and  thereby  maintain  its  profits  at  a  higher  figure. 
If,  indeed,  the  mines  were  nationalized  the  deliberate 
policy  might  be  pursued  of  selling  coal  at  a  price  which 
left  the  industry  no  more  than  self-supporting  as  a 
whole.  Some  coal  might  thus  be  sold  at  less  than  its 
cost  price,  and  the  selling  price  would  conform  roughly 
to  the  average  cost.  But  such  a  policy,  though  in  special 
circumstances  it  might  be  justified,  would  represent  a 
very  dangerous  principle,  which  could  not  be  applied 
widely  without  the  most  serious  results.  Nothing 
could  be  more  fatal  to  any  enterprise,  whether  it  be 
in  the  hands  of  an  individual,  a  joint-stock  company, 
a  State  department,  or  a  Guild,  than  that  the  manage- 
ment should  content  themselves  with  results  which 
in  the  lump  seem  satisfactory,  and  regard  losses 
here  or  there  with  an  indifferent  eye.  That  way  lies 
stagnation,  waste,  progressive  ineflSciency  and  ultimate 
disaster.  To  inquire  searchingly  into  every  nook  and 
cranny  of  the  business,  to  construct,  as  it  were,  for 
each  part  a  separate  balance-sheet  of  profit  and  loss, 
to  expand  in  those  directions  where  further  develop- 
ment promises  good  results,  and  to  curtail  activity 
where  loss  is  already  evident,  is  the  very  essence  of  good 
management.  Here,  it  will  be  observed,  we  are  using 
language  very  similar  to  that  in  which  we  described 
the  principles  which  govern  a  business  man's  expendi- 
ture. The  resemblance  is  inevitable  and  significant,  for 
we  are  dealing  here  with  what  is  essentially  another 
aspect  of  the  same  thing.  The  object  is  to  secure  that 
nowhere  does  expenditure  fail  to  yield  a  commensurate 


COST  AND  THE  MARGIN  OF  PRODUCTION    57 

return.  This  we  express,  when  we  consider  a  business  in 
its  aspect  as  a  consumer,  by  saying  that  its  consumption 
of  anything  will  not  be  carried  beyond  the  point  at 
which  the  marginal  utility  exceeds  the  price  it  will 
have  to  pay.  When  we  consider  it  as  a  producer,  we 
say  that  its  production  of  anything  will  not  be  carried 
beyond  the  point  at  which  the  marginal  cost  exceeds 
the  pri<;e  it  will  obtain. 

§  3.  The  Dangers  of  Ignoring  the  Margin.  This  at  least 
is  the  general  rule.  A  business  may  decide  deliberately 
to  sell  part  of  its  output  below  cost,  because,  for  in- 
stance, this  will  serve  as  an  advertisement,  bring  it  con- 
nections, and  enable  it  to  obtain  a  larger  profit  at  a  later 
date,  or  immediately  on  other  portions  of  its  sales.  In 
so  acting,  it  recognizes  that  the  price  obtained  for  a 
thing  may  be  an  inadequate  measure  of  the  real  return 
it  yields.  In  the  same  way,  though  for  different  reasons, 
a  nationalized  coal  industry  might  conceivably  be 
justified  in  selling  some  coal  below  cost  price,  be- 
cause, let  us  say,  it  held  that  the  price  which  the 
immediate  purchasers  were  willing  to  pay  was  an 
inadequate  measure  of  the  utility  of  coal  to  the  com- 
munity as  a  whole.  But  in  all  such  cases  it  is  essential 
to  be  very  clear  as  to  what  exactly  you  are  doing;  so 
that  you  may  be  at  least  moderately  clear  as  to  whether 
the  policy  is  well  advised.  It  m.ay  be  sound  enough  to 
lose  on  the  swings  and  make  good  this  loss  on  the 
roundabouts,  but  only  if  your  loss  on  the  swings  helps 
you  to  a  larger  profit  on  the  roundabouts.  If  you 
would  get  the  same  return  on  the  roundabouts  in  any 
case,  it  would  be  better  to  cut  the  swings  out  altogether. 


58  SUPPLY  AND  DEMAND 

So,  if  you  are  directing  the  policy  of  a  nationalized  coal 
industry,  and  decide  to  make  a  loss  on  a  portion  of 
your  sales,  you  will  need  to  know  that  the  indirect 
benefit  which  the  community  will  derive  from  this 
particular  part  of  your  coal  output  is  worth  the  loss 
which  you  incur.  You  will  certainly  come  to  grief,  if 
you  pursue  a  vague  ideal  of  lumping  all  results  together, 
and  regarding  a  profit  somewhere  as  a  sufi&cient  excuse 
or  a  positive  reason  for  making  a  loss  elsewhere. 

It  is  quite  true  that  in  big  undertakings,  where  there 
are  large  standing  charges,  and  where  the  organization 
possesses  some  of  the  characteristics  of  an  integral 
whole,  it  is  not  easy  to  measure  accurately  the  specific 
costs  which  should  be  assigned  to  any  particular 
portion  of  the  output.  But  this  difficulty  is  one  of  the 
most  serious  weaknesses  of  large  undertakings;  precise 
detailed  measurement  is  the  great  prophylactic  of 
business  efficiency,  and,  where  it  is  lacking  the  bacilli 
of  waste  will  enter  in  and  multiply.  So  clearly  is  this 
recognized,  that  the  development  of  large  scale  business 
has  led  to  the  evolution  of  new  methods  of  accountancy, 
designed  to  make  detailed  mensuration  possible.  We 
have  most  of  us  heard  of  them  vaguely  under  such 
names  as  "comparative  costings,"  but  too  few  of  us 
appreciate  their  full  significance.  It  is  hardly  too 
much  to  say  that  the  issue  as  to  whether  the  size  of  the 
typical  business  unit  will  continue  to  become  larger  and 
larger,  or  whether  it  has  already  overshot  the  point  of 
maximum  efficiency  will  turn  largely  upon  the  capacity 
of  accountancy  to  supply  large  and  complex  under- 
takings with  more  accurate  instruments  of  detailed 
financial  measurement. 


COST  AND  THE  MARGIN  OF  PRODUCTION    59 

§  4.  ^  Misinterpretation.  The  price,  then,  of  a  com- 
modity tends  roughly  to  equal  its  marginal  cost  of 
production;  and  this  marginal  cost  (in  perfect  sym- 
metry with  what  we  observed  as  regards  marginal 
utility),  may  be  conceived  as  applying  either  to  the 
marginal  producer  or  to  the  marginal  output  of  any 
producer.  In  the  former  aspect  it  is  open  to  a  mis- 
interpretation, against  which  it  will  be  well  to  guard. 
Some  advocates  of  socialism  have  argued,  as  one  of  the 
counts  in  their  indictment  of  the  present  industrial 
system,  that  the  price  of  a  commodity  is  determined  by 
the  cost  at  which  the  least  efficient  concern  in  the 
industry  can  produce.  They  say,  in  effect,  "Under 
the  present  competitive  regime,  you  have  to  pay  for 
everything  you  buy  a  price  which  far  exceeds  the 
necessary  cost  to  a  concern  which  is  managed  with 
ordinary  ability.  For,  as  economic  theory  has  shown, 
it  is  the  cost  of  the  marginal  concern,  i.  e.  the  concern 
managed  by  the  most  incompetent,  and  half-witted 
fellow  in  the  trade;  it  is  the  cost  incurred  by  him, 
together  with  a  profit  on  his  capital,  that  the  price  has 
got  to  cover.  The  producer  of  no  more  than  average 
capacity  is  therefore  making  out  of  you  a  surplus  profit, 
which  would  be  quite  unnecessary  in  any  well-arranged 
society."  Such  an  argument  is  a  gross  caricature  of 
the  marginal  conception.  The  half-witted  incompetent 
will,  as  we  know  well  enough,  speedily  disappear  under 
the  stress  of  competition,  and  his  place  will  be  taken 
by  more  efficient  men.  There  is  an  essential  difference 
between  him  and  the  "marginal  coal  mine"  of  which 
we  spoke  above.  For  the  probabilities  are  that  of  the 
coal  resources,  whose  existence  is  clearly  known,  the 


60  SUPPLY  AND  DEMAND 

more  fertile  and  better  situated  parts  will  already  be  in 
process  of  exploitation;  and  there  is  not  likely,  there- 
fore, to  be  a  supply  of  substantially  better  seams  which 
can  be  substituted  for  the  worst  of  those  in  actual  use. 
There  is  likelj'',  on  the  other  hand,  to  be  available  a 
supply  of  decent  business  capacity  which  can  be  substi- 
tuted for  the  most  inefficient  of  existing  business  men. 
The  marginal  concern,  in  other  words,  must  be  con- 
ceived as  that  working  under  the  least  advantageous 
conditions  in  respect  of  the  assistance  it  derives  from 
the  strictly  limited  resources  of  nature,  but  under 
average  conditions  as  regards  managerial  capacity  and 
human  qualities  in  general.  Thus  in  agriculture  we  can 
speak  of  a  marginal  farm,  which  we  should  conceive  as 
the  least  fertile  and  worst  situated  farm  which  it  is  just 
worth  while  to  cultivate  (of  which  more  will  be  said 
when  we  come  to  the  phenomenon  of  rent),  but  we 
must  assume  it  to  be  cultivated  by  a  farmer  of  average 
ability. 

§  5.  SG7ne  Consequences  of  a  Higher  Price  Level.  The 
foregoing  controversy  will  be  of  service  to  us,  if  it 
makes  clear  the  manner  and  the  spirit  in  which  the 
marginal  conception  should  be  handled.  It  should  be 
regarded  not  as  a  rigid  formula  which  we  can  apply 
to  diverse  problems  without  considering  the  special 
features  they  present,  but  rather  as  a  signpost  which 
will  enable  us  to  find  our  way,  a  compass  by  which  we 
may  steer  between  the  shoals  of  triviality  and  sophistry 
to  the  crux  of  any  problem  with  which  we  have  to  deal. 
Let  us  illustrate  its  practical  uses  by  an  example  which 
is  of  great  interest  and  far-reaching  practical  importance 


COST  AND  THE  MARGIN  OF  PRODUCTION    61 

at  the  present  day.  As  has  been  already  observed,  the 
war  has  left  behind  it  in  all  countries  a  great  and  almost 
certainly  permanent  increase  in  nominal  purchasing 
power.  Since  the  armistice  prices  have  moved  upwards 
and  downwards  with  unprecedented  violence;  and  it 
would  be  very  rash  to  prophesy  the  precise  level  at 
which  they  will  ultimately  settle  (using  that  word  with 
considerable  relativity).  But,  for  reasons  for  which  the 
reader  is  referred  to  Volume  II  in  this  series,  it  is  safe 
enough  to  say  that  the  general  level  of  post-war  will 
greatly  exceed  that  of  pre-war  prices.  Now  this  will 
apply  not  only  to  consumers'  goods  Hke  milk  and 
clothes,  or  to  raw  materials  like  pig-iron  and  cotton, 
but  in  very  much  the  same  degree  to  things  like 
factories  and  machinery.  Things  of  this  last  type  are 
sometimes  called  "  capital  goods,"  because  it  is  in  them 
that  a  large  part  of  the  capital  of  a  business  is  embodied. 
Now  the  fact  that  it  will  cost  much  more  than  it  did 
before  the  war  to  construct  fresh  capital  goods,  has  a 
significance  which  very  few  people  appreciate.  An 
existing  factory  cost,  let  us  say,  $500,000  to  build  and 
equip  with  machinery  before  the  war.  To  construct  a 
similar  factory  to-day  would  cost,  let  us  assume  (it 
is  probably  a  moderate  assumption)  $1,000,000.  Sup- 
pose 10  per  cent  to  be  the  gross  profit  that  is  necessary 
to  attract  capital  to  the  particular  industry.  Then  it 
will  not  pay  to  construct  this  new  factory  unless  the 
trade  prospects  point  to  the  probability  of  a  profit  of 
about  $100,000  per  annum.  But  if  the  old  factory  is 
equally  well  managed,  it  too  should  be  able  to  earn  this 
$100,000,  which  upon  the  capital  actually  sunk  would 
represent  a  rate  of  20  per  cent.    The  particular  figures 


62  SUPPLY  AND  DEMAND 

given  are,  of  course,  purely  illustrative;  the  con- 
clusion to  which  they  point  is  that,  if  new  enterprises 
are  to  be  undertaken,  pre-war  enterprises  are  likely  to 
yield  a  rate  of  profit,  on  their  fixed  capital  at  least, 
increased  in  rough  proportion  to  the  price-level.  Of 
course,  in  years  when  trade  is  bad,  the  factory  which 
dates  from  pre-war  times  will  not  earn  a  profit  of  this 
kind,  it  may  very  likely  make  an  actual  loss.  At  those 
times  it  is  very  certain  that  few  new  factories  will  be 
erected.  But  it  is  diflScult  to  reconcile  a  condition  of 
trade  activity,  in  which  the  constructional  industries 
are  busily  employed,  with  a  rate  of  profit  to  pre-war 
businesses  on  the  fixed  part  of  their  capital  of  a  lesser 
order  of  magnitude  than  has  been  indicated.  It  makes 
no  difference,  it  should  be  observed,  whether  we  suppose 
the  new  enterprises  to  take  the  form  of  starting  of 
new  concerns  or  extending  old  ones;  in  neither  case 
will  they  be  undertaken,  unless  there  is  reason  to 
expect  an  adequate  return  on  the  capital  which  they 
require  at  post-war  constructional  prices.  High  profits 
(taking  always  good  years  together  with  bad)  on  capital 
sunk  before  the  war  in  buildiags  and  machinery  are 
thus  a  likely  consequence  of  an  increase  in  the  price- 
level. 

This  fact  is,  indeed,  the  counterpart  or  complement 
of  another  phenomenon  with  which  we  are  more 
familiar.  While  prices  are  actually  rising,  profits,  as  we 
have  come  to  recognize,  necessarily  rule  high,  because 
every  trader  or  manufacturer  is  constantly  in  the 
position  of  selling  at  a  higher  price-level,  stock  which 
he  purchased,  or  goods  made  from  materials  which  he 
purchased  at  a  lower  level.    He  thus  acquires  an  ab- 


COST  AND  THE  MARGIN  OF  PRODUCTION    63 

normal  profit  on  his  circulating  capital,  which  is 
essentially  similar  to  the  profit  on  fixed  capital,  which 
we  have  just  examined.  The  difference  is  that  the 
former  profit  is  crowded  into  the  years  when  prices  are 
actually  on  the  increase,  and  thus  is  very  noticeable 
indeed;  while  the  latter  profit  continues  to  accrue  in 
smaller  instalments  after  prices  have  settled  down,  as 
it  were,  at  the  higher  level,  and  is  not  exhausted  until 
the  buildings  and  machinery  have  become  obsolete. 
But  the  two  profits  are  essentially  similar,  and  in  the 
long  run  should  be  commensurate.  In  the  one  case, 
stock  can  be  sold  for  a  large  profit,  because  it  cannot 
be  replaced  except  at  a  higher  price;  in  the  other  case, 
plant  and  buildings  j-ield  a  higher  income  because  they 
cannot  be  replaced  except  at  a  higher  price.  Indeed, 
if  the  owners  choose,  the  plant  and  building  can,  like 
the  stock,  be  sold  at  their  appreciated  value,  as  has  been 
widely  done  by  the  owners  of  cotton  mills  in  Great 
Britain  since  the  armistice. 

There  is  nothing  in  these  considerations  that  should 
surprise  us,  or  even  shock  our  moral  sense.  For  what 
they  have  indicated  is  an  increase  of  money  profits  in 
rough  proportion  to  the  price-level,  so  that  the  aggre- 
gate profits  will  represent  about  as  much  real  income  as 
before.^  The  conclusion  therefore  amounts  to  no  more 
than  this,  that  you  cannot  alter  fimdamentally  the 
distribution  of  wealth  between  labor  and  capital  by 
merely  inflating  the  currency,  or  otherwise  juggling 

*  Assuming  that  the  rate  of  interest  has  remained  unaltered. 
In  fact  it  has  greatly  increased  since  pre-war  days,  and  this  points 
to  a  still  further  increase  of  money  profits,  and  an  increase  in  the 
real  income  which  they  represent.     See  Chapter  VIII,  p.  138. 


64  SUPPLY  AND  DEMAND 

with  the  price-level.  And  this  is  only  what  we  should 
expect,  if  there  are  any  laws  of  distribution  of  sufficient 
importance  and  permanence  to  justify  the  many  vol- 
umes which  have  been  devoted  to  them. 

But  this  somewhat  tame  conclusion  does  not  make 
it  any  less  important  to  grasp  clearly  the  significance 
of  the  appreciation  in  the  value  of  capital  goods.  A 
failure  to  realize  it  lies  at  the  root  of  our  bewildered 
muddling  of  many  crucial  problems  of  the  day.  In 
the  matter  of  housing,  for  instance,  v/e  know  we  cannot 
build  houses  at  less  than  two  or  three  times  their  pre- 
war cost,  and  yet  we  cannot  endure  to  see  the  owners 
of  pre-war  houses  obtaining  a  commensurate  increase 
of  rent.  And  so,  in  Great  Britain,  we  pass  Rent  Restric- 
tion Acts,  and  Housing  Acts,  and  then,  in  a  fit  of 
economy  we  suspend  the  latter,  and  let  the  former 
stand,  while  the  housing  shortage  becomes  steadily  more 
acute.  When  we  hand  the  railways  back  from  State 
control  to  private  hands,  our  horror  at  the  idea  of  the 
companies  receiving  larger  money  profits  than  they  did 
before  the  war  leads  us  to  lay  down  principles  for  the 
fixing  of  fares  and  freight  charges,  which  take  no 
account  of  post-war  construction  costs;  and  then,  in 
alarm  lest  we  may  have  thereby  made  it  unprofitable 
for  the  companies  to  spend  a  single  penny  of  fresh 
capital  upon  further  development,  we  seek  to  provide 
for  capital  expenditure  by  cumbrous  and  dubious 
expedients.  Doubtless  we  shall  muddle  through  some- 
how with  such  policies :  and,  public  opinion  being  what 
it  is,  they  may  perhaps  have  been  about  the  best 
policies  that  were  practiable.  But  the  problems  would 
have  been  easier  to  handle,  if  the  public  generally  were 


COST  AND  THE  MARGIN  OF  PRODUCTION    65 

a  little  less  disposed  to  think  in  terms  of  averages,  and 
a  little  more  in  terms  of  margins,  if  we  all  of  us  instinc- 
tively realized  that  the  cost  that  really  matters  is  the 
cost  at  which  additional  production  is  profitable  under 
the  conditions  ruling  at  the  time,  or  in  the  immediate 
future. 

§  6.  General  Relation  between  Price,  Utility  and  Cost. 
Let  us  conclude  this  chapter  by  summing  up  the  con- 
clusions which  have  emerged  as  to  the  relations  of 
utility  and  cost  to  price. 

The  price  of  a  commodity  is  determined  by  the  con- 
ditions of  both  supply  and  demand;  and  neither  can 
logically  be  said  to  be  the  superior  influence,  though 
it  may  sometimes  be  convenient  to  concentrate  our 
attention  on  one  or  other  of  them.  The  chief  factor  on 
which  the  conditions  of  demand  depend  is  the  utility 
(as  measured  in  terms  of  money).  The  chief  factor 
on  which  the  conditions  of  supply  depend  is  the  cost 
of  production  (again  as  measured  in  terms  of  money). 
The  prevailing  trend  towards  an  equilibrium  of  demand 
and  supply  can  thus  be  expressed  as  follows: — 

VI.  A  commodity  tends  to  be  produced  on  a  scale 
at  which  its  marginal  cost  of  production  is 
equal  to  its  marginal  utility,  as  measured  in 
terms  of  money,  and  both  are  equal  to  its 
price. 


yj^f^^y^tjuj;^^'  -  .^^.w^--'-^ 


CHAPTER  V 

JOINT  DEMAND  AND  SUPPLY 

§  1.  Marginal  Cost  under  Joint  Supply.  Several  refer- 
ences have  been  made  above  to  joint  products,  a  rela- 
tion which  it  will  be  convenient  now  to  describe  as  that 
of  Joint  Supply.  Our  sense  of  symmetry  should  make 
us  look  for  a  parallel  relation  on  the  side  of  demand;  and 
it  is  not  far  to  seek.  There  is  a  "joint  demand"  for 
carriages  and  horses,  for  golf  clubs  and  golf  balls,  for 
pens  and  ink,  for  the  many  groups  of  things  which  we 
use  together  in  ordinary  life.  But  the  most  important 
instances  of  Joint  Demand  are  to  be  found  when  we  pass 
from  consumers'  to  producers'  goods.  There,  indeed, 
Joint  Demand  is  the  universal  rule.  Iron  ore,  coal  and 
the  services  of  many  grades  of  operatives  are  all  jointly 
demanded  for  the  production  of  steel;  wool,  textile 
machinery  and  again  the  services  of  many  operatives 
are  jointly  demanded  for  the  production  of  woollen 
goods  (to  mention  in  each  case  only  a  few  things  out 
of  a  very  extensive  list).  Now  we  have  already  noted 
that,  when  commodities  are  jointly  supplied,  there  is 
an  obvious  difficulty  in  allocating  to  each  of  them  its 
proper  share  of  the  joint  cost  of  production.  There  is 
a  similar  difficulty  in  estimating  the  utility  of  a  com- 
modity which  is  demanded  jointly  with  others.  Thus, 
the  utility  of  wool  is  derived  from  that  of  the  woollen 
goods  which  it  helps  to  make.  But  the  utility  of  the 
factories,  the  machinery  and  the  operatives  employed  in 
the  woollen  and  worsted  industries  is  derived  from  pre- 

66 


JOINT  DEMAND  AND  SUPPLY  67 

cisely  the  same  source.  How  much,  then,  of  the  utility  of 
woollen  goods  should  be  attributed  to  the  wool  and  how 
much  to  the  textile  machinery?  Can  we  make  any  sense 
of  the  notion  of  utility  as  applying  to  one  of  these  things, 
taken  by  itself?  And,  if  not,  how  can  we  explain  the 
price  of  a  thing  like  wool  in  terms  of  utility  and  cost, 
since  we  cannot  disentangle  its  cost  from  that  of  mutton, 
nor  its  utility  from  that  of  a  great  variety  of  other  things? 
Here  the  conception  of  the  margin  enables  us  to 
grapple  with  a  problem  which  would  otherwise  be 
insoluble.  For,  while  it  is  impossible  to  separate  out 
the  total  utility  and  cost  of  wool,  it  is  not  impossible 
to  disentangle  its  marginal  utility  and  its  marginal  cost. 
The  proportion  in  which  wool  and  mutton  are  supplied 
cannot  be  radically  transformed;  but  it  can  be  varied 
within  certain  limits,  by  rearing,  for  instance,  a  different 
breed  of  sheep.  Variations  of  this  kind  have  been  an 
important  feature  of  the  economic  history  of  Austral- 
asia, where  sheep  farming  is  the  leading  industry.  Be- 
fore the  days  of  cold  storage,  Australia  and  New  Zealand 
could  not  export  their  mutton  to  European  markets, 
though  they  could  export  their  wool.  Wool  was  accord- 
ingly much  the  most  valuable  product;  the  mutton  was 
sold  in  the  home  markets,  where,  the  supply  being  very 
plentiful,  the  price  was  very  low.  In  the  circumstances, 
the  Australasian  farmers  naturally  concentrated  on 
breeding  a  variety  of  sheep  whose  wool-yielding  were 
superior  to  their  mutton-yielding  qualities.  The 
development  of  the  arts  of  refrigeration  led  in  the 
eighties  to  an  important  change.  It  became  possible  to 
obtain  relatively  high  prices  for  frozen  mutton  in  over- 
seas markets.    There  was,  therefore,  a  marked  tendency, 


68  SUPPLY  AND  DEMAND 

especially  in  New  Zealand,  to  substitute,  for  the  merino, 
the  crossbred  sheep  which  yields  a  larger  quantity  of 
mutton  and  a  smaller  quantity  of  wool  of  poorer  quality. 
Now  if  we  calculate  the  cost  of  maintaining  the  number 
of  merino  sheep  which  will  yield  a  given  quantity  of 
wool,  and  calculate  the  cost  of  maintaining  the  larger 
number  of  crossbred  sheep  which  will  be  required  to 
yield  the  same  quantity  of  wool  (allowing  for  differences 
of  quality)  the  extra  cost  which  would  be  incurred  in  the 
latter  case  must  be  attributed  entirely  to  the  extra 
mutton  that  would  be  obtained.  This  extra  cost  we  can 
regard  as  constituting  the  marginal  cost  of  mutton. 
So  long  as  this  marginal  cost  falls  short  of  the  price 
of  mutton,  it  will  be  profitable  to  extend  further  the 
substitution  of  crossbred  for  merino  sheep.  The  process 
of  substitution  will  in  fact  be  continued  mitil  we  reach 
the  point  at  which  the  marginal  cost  is  about  equal  to 
the  price.  Similarly  by  starting  with  the  numbers  of 
merino  and  crossbred  sheep  which  would  yield  the  same 
quantity  of  mutton,  we  can  calculate  the  marginal  cost 
of  wool;  and  again  the  tendency  will  be  for  this  mar- 
ginal cost  to  be  equal  to  the  price.  ^ 

1  It  may  be  found  difficult  to  grasp  this  point  when  stated  in 
general  terms.  The  following  arithmetical  example  may  make  it 
plainer: — 

Suppose  a  merino  sheep  yields  9  units  of  mutton  and  10  units  of 
wool. 

Suppose  a  crossbred  sheep  yields  10  units  of  mutton  and  8  units 
of  wool. 

Suppose,  further,  that  a  merino  sheep  and  a  crossbred  sheep 
each  cost  the  same  sum,  say,  for  convenience,  £10,  to  rear  and 
maintain;  and  that  there  are  no  special  costs  assignable  to  the 
wool  and  the  mutton  respectively,  as,  of  course,  in  fact  there  are. 

Then  10  merino  sheep,  yielding  90  units  of  mutton +  100  units 


JOINT  DEMAND  AND  SUPPLY  69 

§  2.  Marginal  Utility  under  Joint  Demand.  On  the  side 
of  demand  there  exist  as  a  rule  similar  possibilities  of 
variation.  Some  machinery,  some  labor,  some  mater- 
ials of  various  kinds,  are  all  indispensable  in  the  produc- 
tion of  any  manufactured  commodity.  But  the  propor- 
tions in  which  these  factors  are  combined  together  can 
be  varied,  and  are  frequently  varied  in  practice  as  the 
result  of  the  ceaseless  pursuit  of  economy  by  business 
men.  To  produce  pig-iron,  you  need  both  coal  and 
iron  ore;  but,  if  coal  becomes  more  costly,  it  is  possible 
to  economize  its  use.     Machinery  and  labor  must  be 

of  wool,  cost  £100;  while  9  crossbred  sheep,  yielding  90  units  of 
mutton +72  units  of  wool,  cost  £90. 

Hence  you  could  obtain  an  extra  28  units  of  wool  for  an  extra 
cost  of  £10,  by  maintaining  10  merino  sheep  rather  than  9  cross- 
bred sheep.    The  marginal  cost  of  wool  is  thus  £^^  per  unit. 

Similarly  8  m.erino  sheep,  yielding  72  units  of  mutton +80  imits 
of  wool,  cost  £S0;  while  10  crossbred  sheep,  yielding  100  units  of 
mutton +80  units  of  wool,  cost  £100. 

Hence  you  could  obtain  an  extra  28  units  of  mutton  for  an  extra 
cost  of  £20,  by  maintaining  10  crossbred  sheep  in  place  of  8  mer- 
inos.   The  marginal  cost  of  mutton  is  thus  £|-^  per  unit. 

So  long  as  the  price  obtainable  for  wool  exceeds  £^f ,  and  that 
obtainable  for  mutton  does  not  exceed  £f  ^  per  unit,  it  will  pay  to 
substitute  merino  for  crossbred;  and  conversely.  If  the  price  of 
wool  exceeds  £^  and  the  price  of  mutton  also  exceeds  £|-^,  it  will 
be  profitable  to  expand  the  supply  of  both  breeds,  until  as  the 
result  of  the  increased  supply,  one  of  the  above  conditions  ceases 
to  obtain.  Conversely,  if  the  prices  of  both  products  are  less  than 
the  figures  indicated,  sheep  farming  of  both  kinds  will  be  re- 
stricted. The  resultant  of  the  processes  of  expansion  or  restric- 
tion, and  substitution,  wiU  be  that,  unless  one  of  the  breeds  is 
eliminated,  the  prices  of  mutton  and  wool  wiU  equal  their  respec- 
tive marginal  costs.  These  marginal  costs  maj^,  of  course,  alter 
as  the  process  of  substitution  extends.  For  the  relative  cost  of 
maintaining  merinos  and  crossbreds  will  not  be  the  same  for 
every  farmer.  Here  again  it  is  the  costs  at  the  "margin  of  sub- 
stitution "  that  matter. 


70  SUPPLY  AND  DEMAND 

used  together,  in  some  cases  in  proportions  which  are 
absolutely  fixed.  But  there  is  in  nearly  every  industry 
a  debated  question  as  to  whether  the  introduction  of 
some  further  labor-saving  machine  would  be  worth 
while,  or  some  improved  machine  which  would  represent 
the  substitution  of  more  capital  plus  less  labor  for  less 
capital  plus  more  labor.  A  farmer  can  cultivate  his 
land,  to  use  a  common  expression,  more  intensively  or 
less  intensively;  in  other  words,  he  can  apply  larger 
or  smaller  quantities  of  capital  and  labor  (the  propor- 
tion between  which  he  can  also  vary)  to  the  same 
amount  of  land.  The  problem  is  essentially  the  same  as 
that  of  the  substitution  of  the  crossbred  for  the  merino. 
We  can  take  the  various  possible  combinations  of  the 
factors  of  production,  and  contrast  two  cases  in  which 
different  quantities  of  one  factor  are  employed,  together 
with  equal  quantities  of  the  others.  The  extra  product 
which  will  be  yielded  in  the  case  in  which  the  larger 
quantity  of  the  varying  factor  is  employed  can  then  be 
regarded  as  the  marginal  product  (or  marginal  utility) 
of  the  extra  quantity  of  that  factor;  and  we  can  say 
that  the  employment  of  this  factor  will  be  pushed 
forward  to  the  point  where  this  marginal  product 
will  be  roughly  equal  to  the  price  that  must  be  paid 
for  it.  We  can  thus  lay  down  the  most  important 
proposition  that  the  relation  between  marginal  utility 
and  price  holds  good  generally  of  the  ultimate  agents 
of  production;  that  the  rent  of  land,  the  wages  of 
labor,  and,  we  can  even  add,  the  profits  of  capital  tend 
to  equal  their  (derived)  marginal  utilities,  or,  as  it  is 
sometimes  expressed,  their  marginal  net  products. 
Whenever,  therefore,  the  proportions  in  which  two  or 


JOINT  DEMAND  AND  SUPPLY  71 

more  things  are  produced  or  used  together  can  be 
varied,  the  relations  of  joint  supply  and  joint  demand 
are  perfectly  consistent  with  a  specific  marginal  cost 
and  marginal  utility  for  each  commodity. 

§3.-4  contrast  between  Cotton  and  Cotton-seed,  and 
Wool  and  Mutton.  But  it  sometimes  happens  that  such 
variations  cannot  be  made.  Thus,  it  has  not  been 
found  possible  (so  far  as  I  am  aware)  to  alter  the 
proportions  in  which  cotton  lint  and  cotton-seed  are 
yielded  by  the  cotton  plant.  Roughly  speaking,  you 
get  about  2  pounds  of  cotton-seed  for  every  1  pound  of 
cotton  lint  (or  raw  cotton),  and  though  this  proportion 
may  vary  somewhat  from  plantation  to  plantation,  it  is 
upon  the  knees  of  the  gods,  and  not  upon  the  will  of  the 
planter  that  the  variation  depends.  We  cannot,  there- 
fore, speak  with  accuracy  of  the  separate  marginal  costs 
of  raw  cotton  and  cotton-seed.  It  is  true  that  some 
plantations  are  so  far  distant  from  an}''  seed-crushing 
mill  that  it  is  not  worth  while  to  sell  the  seed  as  a 
commercial  product;  and  it  might  seem,  therefore, 
as  though  we  might  regard  the  entire  costs  of  cotton 
growing  on  such  plantations  as  constituting  the  mar- 
ginal costs  of  raw  cotton.  But  planters,  so  situated, 
derive  a  considerable  value  from  their  cotton-seed  by 
using  it  as  fodder  for  their  live  stock  or  as  a  manure. 
You  can,  of  course,  argue  that  proper  allowance  is 
automatically  made  for  this  factor,  as  a  deduction  from 
the  costs  of  raw  cotton,  when  you  add  up  the  expenses 
of  the  plantation.  In  the  same  way  you  can  deduct  the 
price  which  a  planter  who  sells  his  cotton-seed  obtains 
for  it,  from  the  total  costs  of  the  plantation,  and  call  the 


72  SUPPLY  AND  DEMAND 

remainder  the  costs  of  the  raw  cotton.  But  this  is 
really  to  reason  in  a  circle.  For  in  either  case  the 
magnitude  of  the  deduction  depends  on  the  marginal 
utility  of  the  cotton-seed.  And  the  notion  of  the  cost 
of  anything  becomes  blurred  and  blunted  if  we  so  use 
it  that  it  must  be  deduced  from  the  utility  of  something 
else,  which  is  not  an  agent  in  the  production  of  the 
thing  in  question. 

This  point  is  not  merely  an  academic  one.  It  means 
that  we  cannot  explain  the  relative  prices  of  cotton 
lint  and  cotton-seed  in  terms  of  cost  at  all,  whether 
marginal  or  otherwise.  The  influence  of  cost  will  be 
confined  to  the  sum  of  the  prices  of  the  two  things. 
Upon  this  sum  it  will  exert  precisely  the  same  influence 
as  it  exerts  upon  price  in  general,  by  affecting  the  total 
quantities  of  the  two  things  that  will  be  supplied.  But 
upon  the  distribution  of  this  sum  between  lint  and 
seed,  cost  will  exert  no  influence  whatever,  because  it 
cannot  affect  the  proportions  in  which  they  are  supplied. 
It  may  assist  some  readers  if  I  state  the  matter  in  more 
concrete  terms.  Cost  of  production  will  be  one  of  the 
factors  which  will  result  in  the  production  of  an  annual 
cotton  crop  in  the  United  States  of,  let  us  say,  10  million 
tons  of  seed  cotton.  This  crop  will  yield  roughly  6f 
million  tons  of  cotton-seed,  and  3^  million  tons  (or 
rather  more  than  13  million  bales)  of  lint.  The  com- 
bined price  received  by  the  planter  of  (let  us  say)  14.4 
cents  for  1  pound  of  lint  plus  2  pounds  of  seed  should 
correspond  roughly  to  the  marginal  joint  costs  of  pro- 
duction. But  the  factor  of  cost  has  no  influence  at  all 
in  determining  that  this  combined  price  is  made  up  of 
a  price  of  12  cents  per  pound  for  lint,  and  only  1.2  cents 


JOINT  DEMAND  AND  SUPPLY  73 

per  pound  (or  $24  per  ton)  for  cotton-seed.  To  account 
for  this  we  must  rely  entirely  upon  demand.  We  can 
say,  shortly,  that  the  respective  prices  must  be  such  as 
will  enable  the  demand  to  carry  off  6|  million  tons 
of  seed,  and  3|-  million  tons  of  raw  cotton.  Or  we 
can  go  further  and  say  that  the  marginal  utility  of  a 
pound  of  raw  cotton,  when  3^  million  tons  are  sup- 
plied, is  ten  times  as  great  as  that  of  a  pound  of  seed 
when  6|  million  tons  are  supplied. 

If  accordingly  the  demand  for  cotton-seed  were  to 
expand  considerably  owing,  say,  to  the  discovery  of 
some  new  use  for  the  oil,  which  is  its  most  valuable  con- 
stituent; the  effect  would  be  first  a  rise  in  the  price  of 
cotton-seed,  and,  subsequently,  by  stimulating  cotton 
growing,  a  more  plentiful  supply  and  a  lower  price  for 
raw  cotton.  And  so  far  at  least  as  the  increased  supply 
is  concerned,  this  must  necessarily  be  the  effect,  "other 
things  being  equal";  though,  to  be  sure,  it  might  be 
outweighed  and  obscured  by  other  influences  such  as  the 
boll-weevil.  But  it  is  not  the  case  that  an  increased 
demand  for  mutton  must  necessarily  increase  the  supply 
or  lower  the  price  of  wool;  and  it  is  most  unlikely 
to  do  so  in  any  similar  degree.  For,  here,  the  separate 
marginal  costs  of  the  two  things  exert  their  influence. 
An  increased  demand  for  mutton  will  stimulate  sheep 
farming,  but  it  will  also  stimulate  the  substitution  of 
crossbred  for  merino  breeds;  and  the  resultant  of  these 
two  opposite  tendencies  upon  the  supply  of  wool  is 
logically  indeterminate.  As  a  matter  of  history  we  know 
that  the  development  of  cold  storage  in  the  eighties 
(which  we  may  regard  for  the  present  purpose  as  equi- 
valent to  an  increased  demand  for  Austrahan  mutton) 


74  SUPPLY  AND  DEMAND 

caused  considerable  perturbation  in  the  woollen  and 
worsted  industries  of  Yorkshire.  They  were  faced  with 
a  dwindling  supply  and  a  soaring  price  of  merino  wool; 
and  the  adaptability  with  which  they  met  the  situation, 
and  won  prestige  for  the  crossbred  tops,  and  yarns  and 
fabrics,  to  which  they  largely  turned  is  a  matter  of 
just  pride  in  the  trade  to-day.  The  fact,  however,  that 
this  alteration  in  the  supply  of  wool  was  a  matter  not 
only  of  quantity  but  of  quality,  while  it  takes  nothing 
from  the  substance  of  the  preceding  argument,  makes 
it  difficult  to  draw  a  clear  moral,  bearing  on  the  present 
issue,  from  this  incursion  into  history. 

§  4.  The  Importance  of  being  Unimportant.  The  above 
contrast  between  cases  in  which  variation  is  possible, 
and  those  in  which  it  is  not  possible,  is  reproduced  with 
a  heightened  significance  when  we  turn  back  to  joint 
demand.  The  cases  are  perhaps  less  common  in  which 
it  is  impossible  to  alter  the  proportions  in  which  different 
commodities  are  jointly  demanded,  but  there  are  many 
cases  in  which  it  is  not  nearly  worth  while  to  do  so 
(and  this  amounts  to  very  much  the  same  thing). 
Cases  of  this  sort  are  especially  likely  to  occur  when  we 
are  dealing  with  a  commodity  which  accounts  for  only 
a  tiny  fraction  of  the  costs  of  the  industry  which  is  its 
chief  consumer.  Sewing  cotton,  for  example,  is  jointly 
demanded,  with  many  other  things,  by  the  tailoring 
and  other  clothing  trades;  but  the  money  which  these 
trades  spend  on  sewing  cotton  is  so  small  a  part  of 
their  total  expenditure,  that  no  ordinary  variation  in 
its  price  is  likel.y  to  make  it  worth  while  to  study  the 
ways  and  means  of  using  it  in  smaller  quantities.    When 


JOINT  DEMAND  AND  SUPPLY  75 

sewing  cotton  is  bought  by  the  domestic  consumer, 
considerations  which  are  fundamentally  the  same, 
though  somewhat  different  in  form,  point  to  a  similar 
conclusion.  It  is  thus  very  diflScult  to  assign  to  sewing 
cotton  a  specific  marginal  utility.  This  difficulty  is  of 
great  importance  in  connection  with  the  possibilities 
of  monopolistic  exploitation.  For  it  means  that  the 
demand  blade  of  the  scissors  upon  which  we  rely  to  cut 
off  excrescences  of  price  is  blunted,  and  if  accordingly 
the  producers  constitute  a  strong  enough  combination 
to  control  the  supply  blade,  they  will  possess  an  unusual 
power  of  advancing  their  selling  prices  as  they  choose. 
I  am  far  from  suggesting  that  Messrs.  J.  &  P.  Coats 
are  to  be  condemned  as  an  extortionate  monopoly. 
On  the  contrary,  during  1919,  when  the  profits  in  highly 
competitive  industries  hke  the  main  branches  of  the 
cotton  and  woollen  trades,  soared  exuberantly,  the 
record  of  this  concern  seems  to  me  one  of  distinct 
moderation.  But  the  present  point  is  that  they  possess 
an  exceptional  poivcr  to  fix  the  price  of  sewing  cotton 
as  they  choose,  and  that  this  is  attributable  in  no  small 
degree  to  the  fact  that  sewing  cotton  constitutes  an 
essential  but  relatively  trifling  item  in  the  expenses  of 
the  processes  in  which  it  is  employed. 

Perhaps  the  point  will  be  made  clearer  if  we  turn 
from  the  selling  prices  of  commercial  products,  in  regard 
to  which  there  is  a  strong  and  not  ineffective  public 
sentiment  against  "profiteering,"  to  the  remuneration 
of  different  classes  of  labor.  With  an  instinctive  dis- 
position towards  megalomania,  it  is  often  claimed  in 
Great  Britain  that  the  miners,  being  a  very  numerous 
and    well-organized   body  of  workpeople,   were  in  a 


76  SUPPLY  AND  DEMAND 

stronger  strategic  position  than  most  workpeople 
for  exacting  the  remuneration  they  desire.  It  is 
quite  true  that  a  stoppage  of  work  in  the  coal  in- 
dustry causes  us  a  high  degree  of  inconvenience, 
and  temporary  concessions  may  thereby  be  obtained 
which  might  otherwise  have  been  refused.  But  this 
is  a  dubious  advantage,  and  we  grossly  exaggerate 
its  real  importance.  The  truth  is  that  the  strategic 
position  of  the  miners  in  regard  to  wages  questions  is 
by  no  means  strong.  For  their  wages  constitute  a  very 
large  percentage  of  the  cost  of  coal;  and  the  price  of  coal 
in  its  turn  is  a  most  important  element  in  the  costs  of 
many  of  the  industries  which  are  its  principal  con- 
sumers. Great  Britain,  moreover,  is  far  from  possessing 
a  monopoly  of  coal.  If,  accordingly,  the  wages  of  the 
miners  are  temporarily  pushed  up  to  a  high  point,  the 
result  will  certainly  be  a  diminished  demand  for  British 
coal,  which  will  lead  before  long  to  their  fighting  a  losing 
battle  to  maintain  the  concessions  they  have  won. 
Contrast  their  position  with  that  of  the  steel  smelters, 
whose  wages  (high  though  the  wage  rates  are)  constitute 
a  very  small  percentage  of  the  costs  of  steel  production, 
and  we  must  agree  I  think  that  we  have  in  this  distinc- 
tion the  main  reason  why  the  steel  smelters,  though 
they  hardly  ever  go  on  strike,  have  as  a  rule  been 
able  to  do  so  much  better  for  themselves  than  the 
miners. 

When  a  commodity  or  service  is  such  that  an  appreci- 
able alteration  in  its  price  has  only  a  slight  effect  upon 
the  quantity  demanded,  the  demand  is  said  to  be 
inelastic.  Conversely,  when  a  small  change  in  price 
greatly  alters  the  quantity  demanded,   we  call  the 


JOINT  DEMAND  AND  SUPPLY  77 

demand  elastic.  In  the  former  case,  it  is  worth  nothing, 
a  larger  aggregate  sum  of  money  will  be  spent  upon  the 
thing  when  its  price  is  high  than  when  it  is  low,  while 
the  opposite  is  true  in  the  latter  case.  This  distinction 
is  of  considerable  importance  in  connection  with  many- 
problems  (e.  g.  of  taxation);  and  the  terms,  elastic 
demand  and  inelastic  demand,  are  worth  remembering. 
We  may  thus  express  the  above  conclusions  by  saying 
that  the  demand  for  sewing-cotton  is  highly  inelastic, 
and  that  the  demand  for  coal  miners  is  more  elastic  than 
that  for  steel  smelters. 

§  5.  Capital  and  Labor.  Cases  in  which  it  is  imprac- 
ticable to  make  any  variation  in  the  proportions  in 
which  different  things  are  used  together  are,  however, 
the  exception  rather  than  the  rule.  Where  variation 
is  possible,  we  are  confronted  with  an  uncertainty  as  to 
the  way  in  which  an  increased  supply  of  one  thing  will 
react  on  the  demand  for  another,  similar  to  our  uncer- 
tainty as  to  whether  an  increased  demand  for  mutton 
would  augment  or  diminish  the  supply  of  wool.  It  is, 
for  instance,  of  the  highest  importance  to  give  a  clear 
answer,  if  we  can,  to  the  question  whether  an  increased 
supply  of  capital  will  increase  the  demand  for  labor. 
The  chief  effect  of  an  increased  supply  of  capital  is  to 
facilitate  the  extended  use  of  expensive  machines:  to 
some  extent  these  machines  will  increase  the  demand 
for  labor;  to  some  extent  they  will  be  substituted  for 
it.  Which  of  these  two  tendencies  will  outweigh  the 
other  we  cannot  be  absolutely  sure.  But  fortunately 
we  can  be  far  more  nearly  sure  than  was  possible  in  the 
analogous  case  of  wool  and  mutton.    An  increase  in  the 


78  SUPPLY  AND  DEMAND 

supply  of  capital  increases  the  demand  for  the  com- 
modities, from  which  the  demand  for  labor  is  derived, 
in  both  the  senses  discussed  in  Chapter  II.  First  it 
makes  them  cheaper  to  buy,  and  thus  increases  the 
quantity  that  will  be  bought.  It  is  this  that  is  parallel 
to  the  effect  of  an  increased  demand  for  mutton  in 
making  it  more  profitable  to  breed  sheep.  But  it  also 
serves  to  increase  the  purchasing  power  with  which  to 
buy  commodities,  because  it  increases  the  aggregate 
real  wealth  of  the  community,  and  it  thus  serves  to 
raise  the  whole  demand  curve.  This  last  consideration 
is  so  important  as  to  make  it  overwhelmingly  probable, 
apart  from  the  evidence  of  history,  that  an  increase  in 
the  supply  of  capital  (and  the  same  may  be  said  of  an 
increase  in  the  supply  of  the  other  agents  of  production) 
will  on  balance  increase  the  demand  for  labor.  The 
evidence  of  history  points  to  the  same  conclusion.  The 
history  of  the  last  hundred  years  displays  an  unprece- 
dented accumulation  of  capital,  and  an  unprecedented 
extension  of  machinery,  associated  with  an  unprece- 
dented improvement  in  the  standard  of  living  through- 
out the  whole  community.  This  is  powerful  testimony 
in  favor  of  the  view  that  an  increase  in  the  supply  of 
capital  and  the  use  of  machinery  will  usually  enhance  on 
balance  the  demand  for  labor.  Moreover,  though  this 
is  not  conclusive,  there  is  httle  room  for  doubt  that  an 
obstructive  attitude  towards  the  extension  of  machinery 
in  a  particular  country,  or  a  particular  district,  is  mis- 
guided. For  its  effect  must  be  to  make  production 
more  costly  there  than  it  is  elsewhere,  and  to  lead, 
slowly  perhaps,  but  very  surely,  to  the  transference  of 
the  industry  to  other  regions. 


JOINT  DEMAND  AND  SUPPLY  79 

§  6.  Conclusions  as  to  Joint  Supply  and  Joint  Demand. 
Here,  however,  we  are  beginning  to  digress.  Let  us 
sum  up  in  a  general  form  our  conclusions  as  to  the  way 
in  which  changes  in  the  supply  or  demand  of  a  commod- 
ity react  upon  the  demand  or  supply  of  the  other  things 
with  which  it  is  jointly  demanded  or  suppUed.  Every- 
thing turns,  as  we  have  seen,  on  the  possibility  of 
variation  in  the  proportions  in  which  the  things  are 
used  or  produced  together;  and  this,  it  is  also  clear, 
is  a  matter  of  degree.  Our  conclusions,  therefore,  had 
best  take  the  following  form: — 

VII.  When  two  or  more  things  are  jointly  de- 
manded, in  proportions  which  cannot  easily 
be  varied,  the  tendency  will  be  for  an  increase 
(or  decrease)  in  the  supply  of  one  of  them  to 
increase  (or  decrease)  the  demand  for  the 
others.  These  results  will  be  more  certain, 
and  more  marked,  the  more  difficult  it  is  to 
vary  the  proportions  in  which  the  things  are 
used. 

Similarly,  when  two  or  more  things  are 
jointly  supplied,  in  proportions  which  cannot 
easily  be  varied,  the  tendency  will  be  for  an 
increase  (or  decrease)  in  the  demand  for  one 
of  them  to  increase  (or  decrease)  the  supply 
of  the  others.  These  results  again  will  be 
more  certain  and  more  marked,  the  more 
difficult  it  is  to  vary  the  proportions  in  which 
the  things  are  supplied. 

§  7.  Composite  Supply  and  Composite  Demand.  Joint 
Demand  and  Joint  Supply  do  not  complete  the  list  of 


80  SUPPLY  AND  DEMAND 

relations  between  the  demand  and  supply  of  different 
things.  Between  tea  and  coffee,  or  beef  and  mutton 
there  is  a  relation  of  a  different  kind.  These  things  are 
in  large  measure  what  we  call  "substitutes"  for  one 
another.  An  increased  supply,  and  a  lower  price  of 
mutton,  will  probably  induce  us  to  consume  less  beef. 
This  relation  it  is  convenient  to  describe  as  Composite 
Supply.  Beef  and  mutton  make  up  a  composite  supply 
of  meat;  tea  and  coffee  a  composite  supply  of  a  certain 
type  of  beverage.  For  any  group  of  things,  between 
which  the  relation  of  Composite  Supply  exists,  we  can 
say,  with  complete  generality,  that  an  increased  supply 
of  one  of  them  will  tend  to  diminish  the  demand  for 
the  others.  Parallel  to  the  relation  of  Composite 
Supply  is  that  of  Composite  Demand.  There  are  fre- 
quently several  alternative  uses  in  which  a  commodity 
or  service  can  be  employed;  and  these  alternative  uses 
make  up  a  composite  demand  for  the  thing  in  question. 
Thus  railways,  gasworks,  private  households  and  a 
great  variety  of  industries  contribute  to  a  Composite 
Demand  for  coal.  It  is  worth  noting  that  there  is  fre- 
quently an  association  in  practice  between  Joint  De- 
mand and  Composite  Supply  on  the  one  hand;  and  be- 
tween Joint  Supply  and  Composite  Demand  on  the 
other.  Wool  and  mutton,  for  instance,  we  have  de- 
scribed as  an  instance  of  Joint  Supply;  but,  in  so  far  as 
the  proportions  of  wool  and  mutton  can  be  varied,  we 
can  regard  these  things  as  constituting  a  Composite 
Demand  for  sheep.  And  this  conception  may  help  us 
to  retain  a  clearer  and  more  orderly  picture  of  the  prob- 
lems we  have  discussed  above.  We  can  regard  the  fact 
that  wool  and  mutton  are  produced  together  as  their 


JOINT  DEMAND  AND  SUPPLY  81 

Joint  Supply  aspect,  and  the  fact  that  these  proportions 
can  be  varied  as  their  Composite  Demand  aspect;  and 
the  question  as  to  whether  an  increased  demand  for 
mutton  will  increase  the  supply  of  wool  turns  upon 
whether  the  former  aspect  is  more  important  than 
the  latter.  Similarly  labor  and  machinery,  employed 
together  for  the  same  purpose,  form  an  instance  of 
Joint  Demand;  but  in  so  far  as  they  can  be  substituted 
for  one  another,  they  constitute  a  Composite  Supply  of 
alternative  agents  of  production. 

These  four  relations  of  Joint  Demand,  Joint  Supply, 
Composite  Demand  and  Composite  Supply  are  well 
worth  remembering  and  distinguishing  from  one 
another.  They  are  of  immense  importance  in  every 
branch  of  economic  affairs.  There  are  hardly  any 
economic  problems  upon  which  we  are  fitted  to  express 
an  opinion,  unless  we  have  a  lively  sense  of  the  far- 
reaching  ramifications  of  cause  and  consequence,  of  the 
subtle  and  often  unexpected  interconnections  between 
different  industries  and  different  markets.  To  gape  at 
these  complexities  in  a  confused  stupor  is  as  fooHsh  as 
it  is  to  ignore  them.  But  confusion  and  stupor  are  only 
too  likely  to  represent  our  final  state  of  mind,  if  we 
attempt  to  deal  with  these  complications,  one  by  one 
as  they  occur  to  us,  in  a  piecemeal  and  haphazard 
fashion.  We  need  a  clear  method,  a  systematic  plan 
by  which  we  may  search  them  out,  and  fit  them  into 
place.  The  four  relations  which  we  have  enumerated 
supply  us  with  such  a  plan  and  method.  For  they 
represent  something  more  than  a  series  of  pompous 
names  for  familiar  notions.  They  constitute  a  classifi- 
cation of  the  various  ways  in  which  the  demand  and 


82  SUPPLY  AND  DEMAND 

supply  of  one  thing  can  affect  the  demand  and  supply  of 
others;  a  classification  which  is  exhaustive  when  we 
add  the  relation  of  derived  demand,  and  an  analogous 
relation  on  the  supply  side  which  we  must  now  notice. 

§  8.  Ultimate  Real  Costs.  Just  as  the  utility  of  "pro- 
ducers' goods"  is  derived  from  that  of  the  "con- 
sumers' goods"  which  they  help  to  make;  so  the 
cost  of  any  commodity  is  derived  from  the  cost  of  the 
things  which  help  to  make  it.  Moreover,  just  as  we 
recognize  that  the  utility  of  "consumers'  goods"  lies 
at  the  back  of  all  demand,  and  constitutes  the  ultimate 
end  of  all  production;  so  we  cannot  but  feel,  however 
obscurely,  that  behind  the  phenomena  of  money  costs, 
there  must  lie  certain  ultimate  costs,  of  which  all  money 
costs  are  but  the  measure.  But  when  we  try  to  explain 
what  the  nature  of  these  real  costs  may  be,  we  are 
plunged  in  difficulty.  Wages,  it  may  indeed  seem  at 
first  sight,  present  no  trouble.  There  is  the  effort 
and  the  fatigue,  the  unpleasantness  of  human  labor,  to 
represent  real  costs.  But  can  we  suppose  that  these 
things  are  measured  with  any  approach  to  accuracy  by 
the  wages  which  are  paid  in  actual  fact?  Is  it  true, 
even  as  a  broad  general  rule,  that  the  services  which  are 
most  arduous  and  most  disagreeable  command  the 
highest  price?  And  wages  are  not  the  only  ingredient 
of  money  costs.  There  are  profits:  to  what  real  costs 
do  profits  correspond?  More  difficult  still,  to  what 
does  rent  correspond?  These  plainly  are  not  questions 
upon  which  he  who  runs  may  read.  It  will  be  necessary 
to  devote  the  next  four  chapters  to  their  elucidation. 


CHAPTER  VI 

LAND 

§  1.  The  Special  Characteristics  of  Land.  In  the  great 
process  of  co-operation  by  which  the  wants  of  man- 
kind are  supplied,  Nature  is  an  indispensable  partici- 
pant. She  renders  her  assistance  in  an  infinite  variety 
of  ways,  of  which  the  properties  of  the  soil  which 
man  cultivates  form  only  one;  but  the  sunshine  and 
rain  which  enable  the  farmer  to  grow  his  crops;  the 
coal  and  iron  ore  beneath  the  surface  of  the  earth,  can 
be  regarded  for  our  present  purpose  as  forming  part  of 
the  land  with  which  they  are  associated.  We  can 
thus  concentrate  upon  land  as  the  representative 
of  the  free  gifts  of  nature,  which  are  of  economic 
significance.  Land  in  modem  communities  is  for  the 
most  part  privately  owned.  It  can  be  bought  and  sold 
for  a  price,  and  acquired  by  inheritance.  Moreover,  it 
is  a  common  practice,  particularly  in  the  United 
Kingdom,  for  an  owner  who  does  not  wish  himself  to 
cultivate  or  otherwise  use  the  land,  not  to  sell  it  to  the 
man  who  does,  but  to  lease  it  to  him  for  a  term  of  years 
for  an  annual  payment  which  we  term  rent.  It  is  there- 
fore natural  and  convenient  to  envisage  the  problems, 
which  we  shall  consider  in  this  chapter,  as  problems 
concerning  the  price  and  rent  of  land.  But,  once  again, 
the  laws  and  principles  which  we  shall  state  and 
illustrate  in  terms  of  the  current  systems  of  ownership 

83 


84  SUPPLY  AND  DEMAND 

and  tenure,  possess  a  much  deeper  significance  than 
this  terminology  might  suggest. 

The  fact  that  land  is  a  free  gift  of  Nature  distin- 
guishes it  in  various  ways  from  commodities  which 
are  produced  by  man.  The  peculiarities  which  are  most 
important  from  the  economic  standpoint  are  (1)  that 
the  supply  of  land  is,  broadly  speaking,  fixed  and 
unalterable,  and  (2)  that  its  quality  and  value  vary, 
from  piece  to  piece,  with  a  variation  which  is  immense 
in  its  range,  but  fairly  continuous  in  its  gradation. 
These  are  thus  two  aspects  from  which  the  phenomena 
of  price  and  rent  can  be  regarded;  aspects  which  it  is 
usual  to  call,  (1)  the  scarcity  aspect,  (2)  the  differential 
aspect. 

§  2.  The  Scarcity  Aspect.  The  fact  that  the  supply  of 
land  is  fixed  has  the  following  significance.  If  the 
demand  for  land  increases,  the  price  will  tend  to  rise. 
This  is  also  true,  for  a  short  period  at  least,  of  an 
ordinary  commodity.  But,  in  the  latter  case,  there 
would  ensue  an  increase  in  suppty  which  would  serve  to 
check  the  rise  in  price,  and  possibly,  if  production  on  a 
larger  scale  led  to  improved  methods  of  production, 
bring  the  price  down  eventually  below  its  original  level. 
In  the  case  of  land,  no  such  reaction  is  possible.  There 
is  nothing,  therefore,  to  restrain  the  price  (and  the  rent) 
of  land  from  rising  indefinitely,  and  without  limit, 
if  the  demand  for  it  should  continue  to  increase.  Con- 
versely, if  the  demand  for  land  falls  off,  there  is  nothing 
to  check  the  consequent  fall  in  price  and  rent.  In  the 
case  of  ordinary  commodities,  the  supply  would  be 
diminished,  because  most  things  are  either  consumed 


LAND  85 

by  being  used,  or  wear  out  in  the  course  of  time,  and 
a  regular  annual  production  is  therefore  necessary  to 
sustain  their  supply  at  the  existing  level.  But  land 
remains,  whether  it  is  used  or  not;  and  its  supply  is, 
broadly  speaking,  just  as  incapable  of  being  diminished, 
as  it  is  of  being  increased.  Changes  in  the  demand  for 
land  in  either  direction  are  thus  likely  to  affect  its  price 
in  a  much  greater  degree  than  that  in  which  the  price  of 
an  ordinary  commodity  will  be  affected  by  a  correspond- 
ing change  in  its  demand. 

For  most  purposes,  however,  it  is  of  more  interest 
to  compare  land  with  other  agents  of  production, 
especially  with  capital  and  labor,  rather  than  with 
ordinary  commodities.  Now,  as  we  have  already 
noted,  there  is  some  doubt  as  to  the  manner  in  which 
the  supply  of  capital  or  labor  is  likely  to  be  affected 
by  alterations  in  demand  price.  But  the  supply  of 
capital  and  the  supply  of  labor,  even  if  we  suppose 
them  to  be  as  entirely  unresponsive  to  price  changes  as 
is  the  supply  of  land,  are  at  any  rate  not  fixed.  Not 
only  may  they  vary  for  many  reasons,  but  they  are  in 
fact  likely  to  vary  in  direct  proportion  to  the  population. 
An  increase  in  population  implies  an  increase  in  the 
supply  of  labor;  and  it  is  likely  to  be  accompanied 
by  an  increase  in  the  supply  of  capital;  in  other  words, 
the  supply  of  these  agents  will  expand,  as  the  demand 
for  them  expands.  But  the  supply  of  land  will  remain 
what  it  was.  This  fact  is  enormously  important  in 
connection  with  the  broad  problem  of  population,  which 
will  form  the  theme  of  Volume  VI. 

But  it  is  important  also  in  other  connections.  It  has 
been  the  dominating  factor  in  many  absorbing  con- 


86  SUPPLY  AND  DEMAND 

troversies  upon  high  pohcy  regarding  the  ownership  of 
land,  or  the  taxation  of  land  values,  upon  which  we 
can  touch  but  lightly  here.  It  has  seemed  to  many 
writers  a  reasonable  proposition  to  lay  down,  that  the 
ordinary  course  of  the  progress  of  society,  the  increase 
of  population  and  industry,  must  mean,  as  a  broad 
general  rule,  a  constant  increase  in  the  demand  for  land. 
And,  if  that  be  granted,  it  seems  to  follow  that  the 
price  and  rent  of  land  will  tend  constantly  to  increase. 
John  Stuart  Mill,  accordingly,  in  the  middle  of  the  last 
century,  asserted  that  "the  ordinary  progress  of  a 
society,  which  increases  in  wealth,  is  at  all  times  tending 
to  augment  the  incomes  of  landlords;  to  give  them 
both  a  greater  amount  and  a  greater  proportion  of  the 
wealth  of  the  community,  independently  of  any  trouble 
or  outlay,  incurred  by  themselves,"  ^  and  upon  the 
strength  of  this  assertion,  he  justified  the  policy 
of  imposing  a  special  tax  upon  what  we  have  come 
to  call  the  "unearned  increment"  of  land.  But  how 
far  does  actual  experience  bear  his  assertion  out? 
In  Great  Britain  we  have  seen  in  the  last  half-century 
an  undoubted  increase  in  urban  rents;  but  over  long 
periods  at  least,  there  was  a  marked  fall  in  both  the 
prices  and  rents  of  agricultural  land,  despite  the 
fact  that  the  country  was  "increasing  in  wealth" 
as  rapidly  as  ever  before.  This  was  due,  of  course,  in 
the  main  to  the  increased  supplies  of  wheat  and  other 
foodstuffs  coming  from  the  New  World:  and  if,  accord- 
ingly, we  choose  to  lump  together  not  only  our  own 
urban  and  agricultural  land,  but  the  land  of  other 
countries  as  well,  and  to  speak  vaguely  of  the  demand 
» Principles  of  Political  Economy,  by  John  Stuart  Mill. 


LAND  87 

for  land  as  a  whole,  it  might  seem  as  though  we  could 
argue  that  Mill's  generalization  still  holds  good.  But 
even  this  is  by  no  means  certain  and  in  any  case  such 
a  generalization  is  of  very  little  service:  what  the 
illustration  should  rather  suggest  to  us,  is  the  danger 
of  speaking  of  land  vaguely  as  a  whole,  and  the  impor- 
tance of  turning  our  attention  to  the  variations  in  value 
between  different  kinds  and  different  pieces. 

§  3.  The  Differential  Aspect.  Most  ordinary  commodi- 
ties are  not  produced  on  a  single,  uniform  pattern.  As  a 
rule  there  are  many  variations  of  grade  and  quality, 
and  consequently  of  price.  But  these  variations  are 
usually  designed  to  meet  the  differences  of  taste  among 
the  purchasers,  and  we  do  not  expect  to  find  that  any 
variety  of  an  ordinary  commodity  will  be  produced, 
which  is  so  poor  in  quality  as  to  be  entirely  valueless. 
But  since  it  is  nature  which  has  produced  the  land, 
without  any  assistance  or  guidance  from  man,  there  are 
many  pieces  of  land  which  are  so  unfertile,  or  are  other- 
wise so  unsuitable  for  productive  purposes,  as  to  be 
quite  valueless  from  the  economic  standpoint.  Even 
in  a  densely  populated  country  like  Great  Britain,  there 
are  considerable  tracts  of  land  which  it  is  unprofitable 
to  employ  for  any  economic  purpose  whatsoever,  and 
which  possess  no  further  value  than  what  the  mere 
pride  of  ownership  may  give  them.  This  fact  makes  it 
possible  to  apply  the  conception  of  the  margin  to  the 
case  of  land  with  particularly  illuminating  results. 

In  the  first  place,  however,  it  should  be  observed 
that  the  value  of  any  piece  of  land  does  not  depend 
solely  on  the  intrinsic  fertility  of  the  soil.    The  fact  that 


88  SUPPLY  AND  DEMAND 

land  is  an  immobile  thing  makes  its  situation  a  factor  of 
great  importance.  In  the  case  of  urban  land,  situation 
is,  of  course,  the  only  thing  that  counts.  The  value  of 
a  site  in  Bond  Street  or  the  City  is  entirely  unaffected 
by  its  capacity  or  incapacity  for  potato-growing 
purposes.  But  even  for  agricultural  land,  situation  is  a 
most  important  matter.  A  farm,  which  is  so  remote 
that  considerable  transport  charges  must  be  incurred 
to  bring  its  produce  to  market,  will  be  less  sought  after, 
and  less  valuable,  than  one  which  is  much  better 
situated  though  somewhat  less  fertile.  In  what  follows, 
therefore,  we  must  speak  of  the  "qualit}'^"  of  a  piece 
of  land  in  a  broad  sense  to  include  advantages  of 
situation,  as  well  as  of  fertility.  Let  us  now,  imagine 
the  different  pieces  of  land  in  Great  Britain  to  be 
arranged  in  order  of  quality,  so  that  we  have  a  long 
series,  with  land  of  the  best  quality  at  one  end,  and  of 
the  poorest  quality  at  the  other.  At  the  latter  end,  we 
will  have  such  land  as  is  found  near  the  top  of  Snowden 
or  Ben  Nevis,  which  it  clearly  does  not  pay  to  cultivate 
at  all.  Somewhere,  then,  between  these  two  extremes, 
we  shall  come  to  a  point  where  the  land  is  just,  but  only 
just,  worth  cultivating,  or  where,  to  revert  to  a  form 
of  words  we  previously  employed,  it  is  a  matter  of  doubt, 
whether  the  land  is  really  worth  using  for  a  productive 
purpose.  Such  land  we  can  regard  as  the  "marginal 
land";  and  since  the  variety  of  nature  is  at  once 
infinite  and  fairly  minutely  graduated  we  shall  probably 
find  that  on  one  side  of  this  margin  there  is  much  land 
which  is  only  slightly  superior,  and  on  the  other,  much 
which  is  only  slightly  inferior,  to  the  marginal  land 
itself.    What,  then,  is  likely  to  be  the  value  and  the 


LAND  89 

rent  of  this  marginal  land,  this  land  which  is  just  on  the 
"margin  of  cultivation"?  Some  readers  may  find  the 
answer  startling.  The  rent  of  the  marginal  land  will 
be  nil,  because  it  will  not  pay  to  cultivate  it,  if  any 
appreciable  rent  is  charged.  A  piece  of  land  for  which 
it  is  worth  a  tenant's  while  to  pay  an  appreciable  rent, 
will  not  be  the  marginal  land,  because  there  will  be  land 
just  slightly  inferior  to  it  which  it  will  also  pay  to 
cultivate  if  a  somewhat  lower  rent  is  charged.  And  so 
we  can  pass  to  poorer  and  poorer  qualities  of  land, 
with  an  ever  diminishing  rent,  until  at  the  margin  of 
cultivation  the  derived  utility  of  the  land  is  negligible 
and  the  rent  vanishes. 

This  certainly  is  a  somewhat  abstract  conception; 
but  it  is  by  no  means  so  remote  from  reality  as  may  at 
first  sight  appear.  The  reader  may  protest  that  in  the 
course  of  an  extensive  and  varied  acquaintance  with 
landowners,  he  has  not  yet  run  across  this  peculiar 
marginal  type,  who  lets  his  land  for  no  rent  at  all.  But 
there,  if  his  experience  is  really  extensive,  I  think  he 
is  mistaken.  It  so  happens  that  the  ordinary  agricul- 
tural landowner  leases  out  his  land,  not  by  itself,  but 
together  with  a  variety  of  other  things  such  as  farm 
buildings,  which  it  costs  him  a  considerable  sum  of 
money  to  provide.  He  will  not  as  a  rule  be  willing  to 
go  to  this  expense,  unless  he  sees  his  way  to  obtain  for 
the  farm  an  annual  payment,  which  represents  at  least 
a  fair  return  on  this  capital  outlay,  as  big  a  return  as 
he  could  have  got,  for  instance,  by  investing  the 
same  amount  of  money  in  some  gilt-edged  security. 
This  annual  payment  will,  it  is  true,  be  called  rent; 
but  the  significance  of  this  is  that  what  we  term  rent 


90  SUPPLY  AND  DEMAND 

in  ordinary  life  is  usuallj''  a  complex  thing,  made  up  of 
two  essentially  distinct  elements,  viz.  the  normal  return 
on  the  capital  goods  supplied  together  with  the  land, 
and  what  we  may  call  the  "net  rent,"  or  the  "pure 
rent"  attributable  to  the  land  itself.  Now  will  any 
reader  make  so  bold  as  to  say  that  there  is  no  land  under 
cultivation,  in  respect  of  which  this  net  rent  is  either  nil 
or  negligible?  The  landowners  will  not  agree  with  him. 
It  is  not  a  question,  it  should  be  observed,  as  to  whether 
the  rent  obtained  represents  more  than  a  fair  return  on 
the  purchase  price  paid  for  the  land;  that  is  quite  another 
matter.  The  question  is  whether  the  rent  obtained 
exceeds  a  fair  return  on  the  capital  sum  spent  on  the 
buildings,  etc. ;  with  which  every  farm  must  be  equipped 
to  let  at  all.  In  fact  there  are  not  a  few  farms  where 
there  is  no  such  excess,  and  where  accordingly  there 
is  no  "net  rent"  or  "  pure  rent"  which  can  be  attributed 
to  the  land. 

The  question  whether  it  would  be  profitable  to  cul- 
tivate any  piece  of  land,  turns  upon  whether  the  re- 
ceipts which  would  be  obtained  by  selling  the  produce 
would  exceed  the  costs  of  cultivation:  and  under  these 
costs  of  cultivation  we  must  include,  of  course,  the 
remuneration  of  the  farmer's  services.  Farmers,  like 
other  people,  have  to  live;  and  they  would  not  take 
on  the  troublesome  job  of  farming,  unless  there  seemed 
a  prospect  of  making  a  living  out  of  it.  The  remu- 
neration of  the  farmer  takes,  of  course,  the  form  not 
of  a  salary,  but  of  profits:  and  these  profits  vary  very 
much  from  year  to  year,  and  from  place  to  place,  and 
from  man  to  man.  But  they  are  essentially  payment 
for  work  done,  and  an  ordinary  profit  must  be  regarded 


LAND  91 

therefore  as  part  of  the  necessary  costs  of  farming. 
Thus  it  will  not  be  worth  while  to  cultivate  a  piece 
of  land,  and  the  land  will  in  fact  lie  unused,  upon 
which  a  careful  farmer  might  obtain  a  profit  in  the 
ordinary  sense,  of  no  more  than  $50  or  $100  a  year. 
The  marginal  land  will  be  land  which  yields  a  decent 
profit  to  a  decent  farmer,  as  well  as  a  gross  rent  to  the 
landowner,  sufficient  to  compensate  him  for  his  capital 
outlay,  but  nothing  further. 

What,  then,  will  be  the  rent  of  a  fertile  and  well- 
situated  farm,  about  which  there  is  no  doubt  that  it  is 
well  worth  cultivating?  Part  of  the  gross  rent  which 
the  landowner  receives  must  again  be  regarded  as 
merely  a  return  for  the  capital  expended  in  equipping 
the  farm  for  use;  but  in  this  case,  there  will  be  a  residue 
left  over,  which  constitutes  the  net  rent  of  the  land. 
The  net  rent  will  measure  the  derived  utility  of  the 
land  to  its  occupier,  and  will  in  general  represent 
(very  roughly,  of  course,  in  practice)  the  differential 
advantage  of  cultivating  the  land  in  question  rather 
than  land  on  the  "margin  of  cultivation."  This  differ- 
ential advantage  may  take  either,  or  both,  of  the  forms, 
of  a  larger  produce  per  acre,  or  a  lower  cost  of  produc- 
tion and  marketing.  But,  in  any  case,  the  extra  profit, 
which,  if  no  rent  were  charged,  a  decent  farmer  could 
obtain  by  cultivating  the  farm  in  question,  rather  than 
a  marginal  farm,  will  be  roughly  equal  to  the  net  rent 
which  his  landlord  can  exact  from  him,  if  his  landlord 
so  chooses.  The  landlord  may,  of  course,  not  choose 
to  exact  a  rent  as  high  as  this;  and  as  a  matter  of  fact, 
in  a  country  like  Great  Britain  landlords  often  con- 
tent themselves  with  less.     The  traditions  associated 


92  SUPPLY  AND  DEMAND 

with  the  ownership  of  agricultural  land,  and  with  the 
relations  between  landlord  and  tenant  serve  to  soften 
the  edge  of  economic  law,  and  to  subject  the  rents 
which  are  actually  fixed  to  the  control  in  no  small 
measure  of  the  general  sense  of  what  is  fair  or  cus- 
tomary. In  such  cases  the  landlord  makes  the  farmer 
a  present,  for  the  time  being,  of  part  of  the  economic 
rent.  On  the  other  hand,  as  Irish  agrarian  history 
well  illustrates,  the  landlord  may  sometimes  expro- 
priate under  the  name  of  rent,  permanent  improvements 
which  are  due  to  the  labors  or  the  expenditure  of  the 
tenant.  This  is,  of  course,  particularly  likety  to  happen, 
whenever  it  is  the  custom  to  leave  to  the  tenant  the 
obligation  of  providing  the  capital  equipment  of  the 
farm,  which  in  Great  Britain  is,  for  the  most  part,  the 
recognized  duty  of  the  owner.  Again,  in  the  case  of 
urban  land  in  the  South  of  England,  expropriations 
of  this  kind  are  an  essential  and  well-imderstood  fea- 
ture of  the  leasehold  system.  The  owner  grants  a 
lease  for  a  long  period  of  time,  usually  ninety-nine 
years,  for  a  ground  rent,  which  is  notoriously  below 
the  true  economic  rent  of  the  land,  subject  to  the 
condition  that  the  leaseholder  must  erect  upon  the 
land  and  keep  in  good  repair  certain  buildings,  which 
on  expir>^  of  the  lease  will  become  the  property  of  the 
ground  owner.  Here  the  nominal  ground  rent  is  only 
part  of  the  total  rent  which  is  really  paid;  the  ultimate 
transference  of  the  buildings  representing  often  the 
more  important  part.  There  is,  in  fact,  a  great  variety 
of  systems  of  land  tenure,  some  of  which  are  highly 
complex,  the  respective  merits  of  which  vary  greatly, 
and  which   constitute  a  most  important  problem  for 


LAND  93 

statesmen  and  legislators.  Considerations  of  this  kind 
in  no  way  diminish  the  importance  of  the  general 
analysis  of  rent,  which  we  are  pursuing  in  the  present 
chapter.  Rather  they  make  it  the  more  important, 
because  we  cannot  properly  weigh  the  merits  of  any 
system  of  land  tenure,  until  we  have  grasped  clearly 
the  principles  governing  the  rent  of  land  in  the  purest 
form.  But  certainly  we  must  never  forget  that  the  rent 
we  are  discussing  may  differ  very  greatly  from,  though 
it  will  vitally  influence,  the  money  payments  which 
are  called  rent  in  actual  life.  It  is  the  pure  economic 
rent,  the  rent  which  represents  the  full  annual  pay- 
ment which  it  would  be  worth  paying  to  obtain  the  use 
of  the  land  alone,  which  will  measure,  as  we  have  said, 
the  differential  advantage  of  the  land  in  question 
over  land  on  the  margin  of  cultivation. 

A  clear  grasp  of  this  relation  helps  us  to  perceive 
that  an  increase  in  the  prosperity  of  the  community  may 
sometimes  influence  rents  in  an  unexpected  way.  It 
all  depends  on  the  causes  which  have  given  rise  to 
the  increased  prosperity.  An  advance,  for  instance, 
in  agricultural  science  will  facilitate  a  more  abundant 
supply  of  foodstuffs;  but  it  will  not  necessarily  in- 
crease the  aggregate  rents  of  agricultural  land.  For  if 
it  takes  the  form,  say,  of  the  discovery  of  some  new 
artificial  manure,  it  will  very  likely  facilitate  production 
on  the  less  fertile  soils  far  more  than  it  will  on  the  more 
fertile  soils  where  artificial  manures  are  not  so  neces- 
sary. It  will  thus  tend  to  diminish  the  differential 
advantages  of  working  on  the  more  fertile  farms,  and 
their  rents  will  accordingly  fall,  possibly  by  much  more 
in  the  aggregate  than  any  increase  in  the  rents  of  the 


94  SUPPLY  AND  DEMAND 

farms  near  the  margin  of  cultivation.  The  point  may, 
perhaps,  be  better  imderstood  if  we  pass  from  agricul- 
tural to  urban  land,  and  ask  what  would  be  the  effect 
on  site  values  of  a  great  improvement  in  the  facilities 
of  internal  transport.  Push  the  case  to  an  extreme,  and 
suppose  passenger  transport  to  become  so  cheap  and 
so  quick  that  there  ceases  to  be  any  advantage  in 
living  in  a  town  so  as  to  be  near  your  place  of  work. 
Urban  landlords  would  no  longer  be  able  to  obtain  the 
high  rents  they  now  receive  for  the  sites  of  houses 
in  or  near  a  town.  For  most  people  would  prefer  to 
move  out  into  the  country  where  sites  can  be  obtained 
at  little  more  than  an  agricultural  rent.  The  country 
covers  so  large  an  area  relatively  to  the  towns  that 
the  supply  of  rural  sites  would  be  still  very  plentiful  as 
compared  with  the  demand.  Their  rents  would  not, 
therefore,  rise  by  very  much,  although  the  rents  of  the 
housing  sites  in  towns  would  fall  heavily.  Of  course, , 
there  are  other  factors  to  be  taken  into  account  before 
we  could  pronounce  upon  the  effect  on  aggregate  rents. 
Central  sites  for  shops  might,  for  instance,  fetch  a 
higher  rental  than  before.  The  purpose  of  this  discus- 
sion is  not  to  generalize  but  to  show  the  danger  of  gen- 
eralizing about  rents  in  the  aggregate,  or  land  as  a  whole. 

§  4.  The  Margin  of  Transference.  The  last  illustration 
may  serve,  however,  to  remind  us  of  an  obvious  fact 
which  we  must  now  take  into  account.  The  same 
piece  of  land  may  be  used  for  a  variety  of  purposes. 
It  may  have  been  used  for  growing  corn,  and  later  it 
may  be  devoted  to  the  building  of  houses,  or,  as  at 
Slough,  to  a  repair  depot  for  motor  vehicles.    It  need 


LAND  95 

hardly  be  said  that  the  land  will,  as  a  general  rule, 
be  put  to  the  use  in  which  its  value  is  greatest;  or  to 
speak  more  strictly,  in  which  the  biggest  rent,  or  the 
biggest  selling  price  can  be  obtained.  But  the  notion 
of  the  differential  advantages  which  a  piece  of  land 
possesses  over  the  marginal  land  becomes  decidedly 
more  complicated  when  we  take  account  of  this  variety 
of  uses.  Let  us  turn  our  attention,  for  instance,  to  the 
sites  used  for  shop  and  office  purposes,  and  consider 
what  we  can  regard  as  the  marginal  site  in  this  connec- 
tion. Clearly  it  will  not  be  the  marginal  land  of  which 
we  spoke  above,  which  it  only  just  paid  to  cultivate, 
and  which  yielded  no  rent  at  all.  For  this  will  prob- 
ably be  agricultural  land  in  an  out-of-the-way  dis- 
trict, where  no  one  would  dream  of  setting  up  an  office 
or  a  shop.  Any  site  upon  which  a  sane  man  would  con- 
template setting  up  a  shop  will  certainly  possess  value 
for  other  purposes,  such  as  house-building.  Hence  the 
marginal  site  for  shopkeeping  purposes  will  not  be  like 
our  marginal  farm,  a  site  which  yields  no  rent. 

As  regards  many  pieces  of  land,  there  is  no  doubt 
as  to  the  purposes  for  which  they  can  most  profitably 
be  used.  This  piece  will  command  a  much  higher  rent 
as  a  shop  site  than  in  any  other  capacity;  for  that  piece 
house-building  is  the  obvious  employment;  for  another, 
agriculture.  But  in  quite  a  number  of  instances  there 
is  considerable  uncertainty.  It  is  not  clear  whether 
upon  this  site  it  will  be  better  to  erect  a  house  or  a  shop, 
or  if  the  latter,  what  kind  of  a  shop.  It  is  not  clear 
whether  it  will  pay  to  use  that  farm  land  for  a  building 
scheme;  and,  within  the  domain  of  agriculture,  which 
of  course  comprises  an  immense  variety  of  really  dif- 


96  SUPPLY  AND  DEMAND 

ferent  industries,  it  is  often  a  very  moot  point  indeed 
whether  a  certain  field  should  be  left  under  grass,  or 
brought  under  the  plow.  Cases  of  this  sort  are  not  phan- 
toms of  the  imagination;  they  emerge  on  every  side  as 
concrete  problems  with  which  some  one  or  other  is  deal- 
ing every  day,  and  it  is  these  cases  which  constitute  the 
marginal  land  for  the  purposes  of  a  particular  occupa- 
tion. The  marginal  sites  for  shops  are  the  sites  for  which 
it  is  only  just  worth  while  to  pay  rents  sufficient  to  entice 
them  away  from  houses.  And  the  rent  for  a  site  in  Bond 
Street,  or  elsewhere,  which  is  so  much  more  suitable  for 
shop  purposes  that  no  alternative  use  would  be  worth 
considering,  will  exceed  the  rent  paid  for  one  of  these 
marginal  sites  by,  roughly  speaking,  the  extra  advan- 
tage it  possesses  for  shop  purposes.  Or  will  fall  short  of 
it,  it  may  be  well  to  add,  to  the  extent  of  its  comparative 
disadvantage.  For  there  may  be  many  such  marginal 
sites,  some  of  which  will  fetch  low  rents,  and  others 
very  high  rents  indeed;  the  same  site  being  often  of 
great  potential  utility  for  a  large  variety  of  occupa- 
tions. Between  any  two  occupations  there  will  thus 
usually  be  a  margin  of  transference,  which  we  must  con- 
ceive not  as  a  point,  but  as  an  irregular  line,  upon  or 
near  to  which  there  will  be  many  pieces  of  land,  differ- 
ing greatly  in  the  rents  which  they  fetch.  These  varia- 
tions of  rent  will  correspond  to  the  differences  between 
the  advantages  or  derived  utilities  which  the  sites 
possess  for  both  the  occupations  in  question.  The 
position  of  such  margins  of  transference  will  of  course 
alter  as  industrial  conditions  change,  and,  when  they 
alter,  the  rents  of  sites  which  are  not  near  any  margin 
of  transference  will  be  affected  also.    Thus  an  increased 


LAND  97 

demand  for  the  products  of  any  particular  industry 
will  make  it  profitable  for  that  industry  to  offer  liigher 
rents,  and  thus  draw  land  away  from  other  occupa- 
tions. This  will  have  the  elTect  of  raising,  though 
possibly  to  a  very  slight  extent,  the  rents  of  sites  which 
still  remain  in  other  uses;  for  there  will  be  fewer  of 
them  available;  and  their  derived  utilities  will  con- 
sequently be  increased. 

But  here,  as  everywhere,  it  is  upon  the  margin  that 
our  attention  should  be  focussed,  because  it  is  round 
about  the  margin  (wherever  it  is  found)  that  the 
changes  are  taking  place  which  really  matter  for  society. 
When  Mr.  Mallabj^'-Deeley  buys  an  estate  in  Covent 
Garden  from  the  Duke  of  Bedford,  the  transaction 
hardly  deserves  the  degree  of  public  interest  it  excites. 
Nothing  has  happened  which  is  of  material  consequence 
to  anyone  except  the  two  gentlemen  concerned;  the 
various  sites  are  still  used  for  the  various  purposes  for 
which  they  were  used  before;  nothing  has  occurred 
that  really  matters.  But  when  houses  are  pulled  down 
for  the  erection  of  a  cinema,  or  when  a  field  is  diverted 
from  tillage  to  pasture,  something  has  happened  which 
affects  for  good  or  ill  the  interests  of  the  whole  com- 
munity. Conversion  from  tillage  to  pasture  represents, 
indeed,  a  tendency  which  has  been  very  marked  in 
Great  Britain  during  the  last  generation,  and  has 
aroused  misgivings  in  many  public-spirited  observers. 
Possibly  for  a  variety  of  reasons,  these  misgivings  may 
be  justified;  certainly  the  problem  is  well  worthy  of 
attention.  But  when  in  this  way  the  issue  is  raised  of 
tillage  versus  pasture,  it  is  essential,  if  we  are  to  dis- 
cuss it  rationally,  that  we  should  envisage  it  clearly 


98  SUPPLY  AND  DEMAND 

as  applying  only  to  a  limited  portion  of  agricultural 
land,  to  the  portion  which  lies  somewhere  near  the 
margin  of  transference,  as  things  are  now,  between 
the  two  forms  of  agiiculture.  It  might  be  socially 
desirable  to  bring  under  the  plow  a  field  which  the 
farmer  finds  it  only  slightly  more  profitable  to  lease 
under  grass;  but  this  would  be  highly  improbable 
in  the  case  of  a  field  where  the  balance  of  argument 
to  the  farmer  in  favor  of  pasture  is  overwhelming. 
The  position  of  the  margin  of  transference  between 
different  uses  may,  in  other  words,  be  somewhat  out  of 
place  from  the  social  point  of  view,  and  it  may  be 
desirable  by  appeals  and  propaganda,  even  conceiv- 
ably by  the  devices  of  State  subsidy  and  compulsion, 
to  push  it  forwards  or  backwards  in  greater  or  less 
degree.  But  it  will  be  necessarily  a  matter  of  degree, 
and  nothing  could  be  more  foolish  than  to  speak  as 
though  there  was,  or  could  be,  some  ideal  method  of 
cultivation  equally  applicable  to  all  lands,  without 
regard  to  their  climatic  and  other  conditions.  Needless 
to  say,  none  of  the  agricultural  experts  who  sometimes 
deplore  the  decline  of  arable  farming  are  guilty  of  such 
foolishness.  But  the  sense  of  the  diversity  of  nature 
which  is  very  vivid  to  them  may  sometimes  be  lacking  in 
people  who  live  in  towns,  and  a  firm  grasp  of  the  mar- 
ginal notion  may  serve  best  to  keep  the  latter  from 
forgetting  it. 

§  5.  The  Necessity  of  Rent.  Behind  all  such  detailed 
applications  there  lies  a  more  general  consideration 
which  deserves  attention.  The  way  in  which  the  land 
of  a  country  is  used,  the  way  in  which  it  is  apportioned 


LAND  99 

between  the  countless  alternative  employments  that  are 
possible,  is  a  most  important  matter,  more  important 
perhaps  than  any  questions  as  to  the  size  of  the  incomes 
which  particular  landowners  receive  by  virtue  of  their 
rights  of  ownership.  How  is  this  apportionment 
effected  as  things  are  now?  The  answer  is  clear:  mainly 
by  the  agency  of  either  rent  or  price.  The  business 
which  finds  it  worth  while  to  oflFer  the  highest  rent  or  the 
highest  price  for  any  piece  of  land  will,  as  a  rule,  be 
able  to  command  its  use.  And,  with  this  as  the  govern- 
ing principle,  an  apportionment  is  secured  between 
shops,  offices,  factories,  agriculture,  between  the  im- 
mense variety  of  different  employments  covered  by 
each  of  these  broad  headings;  not  a  rigid  unvarying 
apportionment,  but  one  which  constantly  changes  as 
economic  circumstances  change,  and  as  the  margin  of 
transference  between  different  occupations  moves  hither 
and  thither.  This  apportionment  takes  place  at  present 
as  the  result  of  the  independent  decisions  and  bargains 
of  many  private  individuals,  who  are  thinking  mainly  of 
their  own  interests,  and  not  of  those  of  the  community. 
But  this  state  of  affairs  might  be  altered.  The  land 
might  be  nationaHzed  and  allocated  to  its  various  uses 
by  the  co-ordinated  labors  of  a  great  State  department, 
or  some  other  agency  of  the  collective  will.  However 
improbable  such  a  change,  it  is  perfectly  conceivable. 
But  what  is  not  conceivable  is  that  any  State  depart- 
ment should  handle  the  job  wdth  a  success  even  ap- 
proaching that  of  the  present  system,  unless  it  con- 
tinued to  use,  as  its  main  instrument,  the  criterion  of 
either  rent  or  price.  That  a  piece  of  land  would  yield  a 
higher  rent  in  one  occupation  than  in  any  other  is  not 


100  SUPPLY  AND  DEMAND 

conclusive  evidence  that  it  is  best  to  devote  it  to  the 
former  purpose,  Ijut  it  is  very  good  evidence,  and  it 
should  be  allowed  to  prevail  unless  it  is  demonstrably 
outweighed,  as  it  possibly  might  often  be,  b}''  considera- 
tions of  a  different  kind.  That  it  would  not  be  well  for 
the  community  to  employ  land  in  the  city  of  London  for 
corn-growing  purposes,  however  desirable  might  be  a 
revival  of  home  agriculture,  is  so  obvious  that  it 
may  seem  to  have  no  bearing  on  the  present  issue. 
But  it  is  only  an  extreme  indication  of  the  absurd 
and  wasteful  use  of  our  natural  resources,  which  would 
grow  up  slowly  but  surely,  if  we  dispensed  with  ideas  of 
rent  and  price  as  sordid  irrelevancies,  and  allocated 
our  land  on  the  basis  of  a  balancing  of  the  loftiest 
arguments  of  a  vague  and  sentimental  character.  If 
you  are  prepared  for  the  distribution  of  land  to  become 
stereotyped,  for  each  piece  to  continue  indefinitely 
in  its  present  use,  then  indeed  you  might  dispense  with 
rent,  as  primitive  societies  very  largely  do.  That  would 
mean  stagnation  and,  for  an  industrial  country,  decay. 
But  if  changes  are  ever  to  be  contemplated,  a  simple 
quantitative  measure  is  the  only  safeguard  against  utter 
chaos.  Thus  rent,  like  interest,  will  be  found  indispen- 
sable as  a  measure  under  any  efficient  system  of  society, 
even  if  it  might  not  always  represent  the  payment  of 
sums  of  money  to  private  individuals.  And  that  is  why 
the  principles  governing  rent  possess,  as  I  indicated  at 
the  outset  of  this  chapter,  an  importance  more  funda- 
mental than  our  present  system  of  ownership  and  tenure. 

§  6.  The  Question  of  Real  Costs.  But  we  must  not 
forget  the  preliminary  question  that  started  us  upon 


LAND  101 

our  anabasis  of  the  agents  of  production.  The  rent 
which  a  manufacturer  or  farmer  has  to  pay  for  his  land 
he  naturally  includes  in  his  cost  of  production.  But 
does  this  money  cost  to  the  individual  correspond 
to,  and  measure,  any  real  cost  to  the  community  as  a 
whole?  Here  let  us  note  in  the  first  place  that  if  only 
we  could  disregard  the  variety  of  uses  to  which  land  is 
put,  if  we  could  suppose  that  all  industry  was  agricul- 
ture, and  that  agriculture  was  a  single  industry  with  a 
single  product,  we  could  argue  that  rent  does  not  enter 
into  marginal  costs  at  all.  For  we  could  regard  the 
marginal  producer  as  the  one  working  on  a  marginal 
farm,  whereas  we  have  seen  there  is  no  pure  rent.  The 
rent  which  other  producers  have  to  pay  would  thus 
represent  merely  the  destination  of  the  surplus  profits 
which  arise  wherever  actual  costs  fall  short  of  marginal 
costs.  This  way  of  looking  at  the  matter  has  proved 
attractive  to  some  thinkers,  not  in  the  least  because  of  a 
desire  to  palliate  the  effects  of  landlordism,  but  because 
it  fits  in  so  well  with  our  general  sense  of  rent  as  a 
"surplus,"  and  a  surplus  as  something  distinct  from  a 
necessary  price.  But  it  is  clearly  illegitimate  in  an 
economic  theory  which  professes  "to  describe  the 
facts."  The  marginal  land  for  many  purposes  fetches, 
as  we  have  seen,  a  considerable  rent;  and  this  rent  is 
certainly  part  of  the  marginal  costs  and  of  the  necessary 
price  of  the  products  of  the  particular  industry.  The 
answer  to  our  question  is,  however,  not  now  very  difii- 
cult  to  see.  Land,  greatly  as  it  differs  in  many  respects 
from  the  other  agents  of  production,  resembles  them  in 
the  very  important  respect  that,  being  used  for  one 
purpose,  it  is  not  available  for  other  purposes,  and  that 


102  SUPPLY  AND  DEMAND 

the  productive  powers  of  the  community  in  other  direc- 
tions are  thereby  diminished.  This  is  the  real  cost  to 
the  community,  which  attaches  to  the  products  of  any 
industry,  in  virtue  of  the  land  which  it  occupies; 
not  any  human  labors  or  sacrifices  required  to  produce 
the  land  itself,  but  the  curtailment  of  the  natural 
resources  available  for  productive  use  elsewhere.  This 
is  the  real  cost  of  which  rent  is  the  money  measure, 
and  generally  speaking  an  accurate  measure  at  the 
margin  of  transference  between  one  occupation  and 
another.  A  somewhat  fanciful  use  of  the  term  cost, 
this  may  seem  perhaps,  one  not  quite  in  accordance 
with  our  instinctive  sense  of  what  real  costs  should  be. 
But  possibly  the  real  costs  represented  by  wages  and 
profits  may  turn  out  to  be  not  so  very  different,  and 
we  had  best  leave  the  matter  there,  until  we  have 
examined  the  nature  of  these  other  costs. 

§  7.  Rent  and  Selling  Price.  In  this  chapter  we  have 
spoken  mainly  of  the  rent  rather  than  the  price  of  land : 
the  relation  between  the  two  things  is  fairly  obvious 
and  well  understood,  but  it  will  be  well  not  to  close 
the  chapter  without  a  brief  account  of  it.  The  price  of 
any  piece  of  land  is  affected  by  all  the  considerations  on 
which  its  rent  depends,  but  it  is  also  affected  by  another 
factor  which  has  no  influence  v/hatever  upon  rent. 
This  factor  is  the  rate  of  interest.  The  higher  the  rate 
of  interest,  the  higher  the  return  which  a  man  could 
obtain  by  buying  gilt-edged  securities,  the  lower  wiU 
be  the  price  that  he  will  pay  for  a  piece  of  land  which 
yields  a  given  rent.    We  can  express  the  relation  more 

precisely  by  the  formula  Price  =  ^7-7 — t-t-t ->  though 

^  *^  Rate  of  Interest 


LAND  103 

we  must  be  careful,  in  applying  this  formula  in  practice 
to  allow  for  the  possible  deviations  between  the  nominal 
and  the  true  rent,  and  similar  complications.  The 
price,  it  must  be  observed,  is  derived  in  this  way  from 
the  rent,  not  the  rent  from  the  price. -^  Rent  is  thus 
logically  the  simpler,  price  the  more  complex  thing. 
It  is  well,  therefore,  to  analyze  in  the  first  instance  the 
principles  of  rent,  if  we  live  in  a  country  where  the 
practice  of  leasing  land  for  annual  rent  is  less  common 
than  it  is  in  Great  Britain,  even  if,  for  whatever  reason, 
it  is  the  price  of  land  with  which  we  are  concerned  in 
practice.  The  problem  of  price  contains  two  distinct 
elements  which  it  is  not  easy  to  handle  when  mixed  up 
together.  For  the  rate  of  interest  represents  in  itself 
an  important  branch  of  economics,  which  will  require 
a  separate  chapter  to  itself. 

1  In  this  the  rent  of  land  differs  fundamentally  from  that  of 
other  things,  such  as  houses.  For  the  price  of  a  house  is  largely 
influenced  by  the  costs  of  construction  of  new  houses,  and  should 
correspond  closely  to  them  in  the  long  run.  The  same  relation 
between  rent,  price  and  rate  of  interest  will  hold  good;  but  the 
rents  will  be  affected  by  changes  in  the  rate  of  interest,  owing  to 
the  reactions  of  such  changes  on  the  supply  of  houses. 


CHAPTER  VII 

RISK-BEARING  AND  ENTERPRISE 

§  1.  Profits  and  Earnings  of  Management.  The  profits 
of  a  business,  as  they  are  ordinarily  reckoned,  whether 
for  the  purposes  of  income  tax  or  of  a  balance  sheet, 
comprise  several  elements  which  are  fundamentally 
distinct.  The  relative  importance  of  these  various 
elements  varies  greatly  from  one  tj^pe  of  business  to 
another.  The  profits  of  a  private  business  include,  for 
instance,  the  remuneration  of  the  work  of  management, 
which  in  the  case  of  a  Joint  Stock  Company  is  mostly 
paid  for  by  salaries  or  directors'  fees.  It  is  to  their  profit 
that  farmers,  small  shopkeepers,  and  the  partners  of 
a  private  firm  look  not  merely  for  a  return  upon  their 
capital,  but  for  the  reward  of  their  own  labors.  "  Earn- 
ings of  Management,"  as  they  are  usually  termed 
(though  in  truth  they  often  cover  other  and  humbler 
forms  of  labor)  are  thus  frequently  one  of  the  ingredi- 
ents of  profits. 

§  2.  The  Payment  for  Risk-hearing.  There  is  another 
element  of  great  importance  about  which  our  ordinary 
ideas  are  apt  to  be  so  vague  that  it  will  be  well  to  devote 
a  chapter  to  its  examination.  This  is  the  element  of 
payment  for  risk,  or  rather  the  reward  of  risk-bearing. 
Risk  is  inherent  in  all  business,  as  it  is  inherent  in  all 
life.    The  vagaries  of  nature  and  the  vagaries  of  man 

104 


RISK-BEARING  AND  ENTERPRISE      105 

are  alike  responsible.  The  farmer  may  find  his  harvest 
ruined  by  a  drought  or  by  a  deluge;  the  coal  or  the  gold, 
for  the  extraction  of  which  you  have  perhaps  set  up 
an  extensive  mining  plant,  may  come  to  an  end  which 
is  unexpectedly  abrupt.  You  may  put  your  money 
into  roller-skating  rinks  and  find  that  cinemas  have 
become  the  rage  with  the  fickle  public;  sometimes 
"the  market"  may  decline  for  causes  which  remain 
obscure  but  with  consequences  which  are  disagreeably 
plain.  But  while  risk  is  always  present  in  some  degree, 
the  degree  varies  enormously  from  one  industry  to 
another.  Now,  it  is  obvious  enough  that  in  an  excep- 
tionally risky  industry,  where  there  is  a  considerable 
possibihty  that  the  capital  invested  will  yield  no  return 
at  all,  the  profits  of  those  concerns  which  succeed 
are  Hkely  to  exceed  the  rate  of  interest  on  gilt-edged 
securities.  But  what  is  likely  to  be  the  magnitude  of 
this  excess?  Is  risk-taking  rewarded  if  there  is  any  such 
excess,  however  small?  Or  will  it  suffice  that  the  gains 
and  losses  should  average  out  to  a  fair  rate  of  interest 
over  the  whole  industry?  To  enable  us  to  think  closely 
let  us  suppose  for  a  moment  that  we  can  measure 
accurately  what  the  chances  are. 

Suppose,  then,  that  there  were  a  precisely  equal 
chance  of  success  on  the  one  hand  and  failure  on  the 
other  in  any  enterprise,  failure  involving  a  complete 
loss  of  all  the  capital  invested.  Suppose,  further, 
6  per  cent  to  be  at  the  time  a  fair  return  on  a  perfectly 
secure  investment.  What  would  be  the  return  which 
must  be  expected  from  the  risky  enterprise,  in  the 
event  of  its  succeeding,  before  it  will  be  undertaken? 
The  reader  may  be  tempted  to  answer,  12  per  cent. 


106  SUPPLY  AND  DEMAND 

But  12  per  cent  would  not  suffice.  An  equal  chance 
of  12  per  cent  or  nothing,  as  compared  with  a  certainty 
of  6  per  cent,  does  not  mean  that  the  risk  in  the  former 
case  is  paid  for  to  the  tune  of  6  per  cent.  It  means 
that  it  is  not  paid  for  at  all.  In  each  case  what  a 
mathematician  would  call  the  expectation  is  a  return 
of  6  per  cent.  The  odds  are  evenly  balanced;  in  the 
long  run,  over  a  large  number  of  cases,  if  the  law  of 
averages  works  as  we  assume  it  does,  you  would  get 
just  as  much  from  the  one  type  of  investment  as  the 
other.  Now,  risky  enterprises  will  not,  as  a  rule,  be 
undertaken  on  terms  like  these;  investors  and  business 
men  will  not  take  risks  with  the  odds  precisely  equal; 
they  must  have  them,  or  believe  that  they  have  them, 
in  their  favor. 

§  3.  Monte  Carlo  and  Insurance.  To  assert  this  is  not 
to  ignore  the  strength  of  the  appeal  which  the  gambling 
instinct  makes  to  many,  if  not  to  most  of  us.  The 
taste  for  gambling  is,  indeed,  so  deep  and  widespread 
that  it  would  be  foolish  to  leave  it  out  of  account  in  this 
connection.  It  is  clear  enough  that  at  places  like  Monte 
Carlo  people  are  prepared  to  have  the  odds  unmistak- 
ably against  them,  apparently  for  the  sheer  pleasure 
and  exhilaration  of  taking  risks.  Moreover,  though  for 
most  people  play  at  Monte  Carlo  represents  a  mere 
holiday  indulgence,  it  would  be  unsafe  to  assume  that 
what  appeals  to  them  there  will  not  also  appeal  to  them 
in  their  business  affairs.  But  what  exactly  is  the  secret 
of  the  charm  of  Monte  Carlo?  It  is  the  great  attractive 
force  of  a  small  chance  of  a  large  gain,  as  compared 
with  the  deterrent  force  of  a  large  chance  of  a  small  loss. 


RISK-BEARING  AND  ENTERPRISE      107 

People  will  readily  pay  $5  for  one  chance  in  a  hundred 
of  making  no  more,  perhaps,  than  $400  or  $450,  And  it 
is  very  likely  that  this  holds  good  in  the  world  of  busi- 
ness. If,  for  example,  we  were  to  suppose  that  the  pro- 
moters of  a  new  enterprise  were  confronted  with  one 
chance  in  fifty  of  a  profit  of  50  per  cent  per  annum  on 
their  capital,  as  against  forty-nine  chances  of  a  profit  of 
5  per  cent,  this  might  well  prove  a  more  attractive  pros- 
pect than  a  certain  return  of  6  per  cent,  although  the 
strict  expectation  of  profit  would  be  smaller  in  the  former 
case.  But  the  risks  of  business  enterprise  are  not 
often  of  this  type.  They  conform  more  usually  to 
the  opposite  type  of  a  large  chance  of  a  relatively 
small  gain,  balanced  by  a  small  chance  of  serious 
loss  or  entire  failure.  Now  for  almost  everyone  the 
possibility  of  a  great  loss  will  count  as  a  deterrent 
(just  as  the  possibility  of  a  great  gain  may  count  as 
an  attraction)  for  much  more  than  its  strict  actuavial 
value. 

The  truth  of  this  proposition  is  demonstrated  by  the 
existence  of  institutions  more  impressive  than  Monte 
Carlo — the  Insurance  Companies,  which  play  so  large 
a  part  in  the  economic  fife  of  modern  times.  Every 
year,  and  upon  an  ever-growing  scale,  both  private 
individuals  and  business  concerns  pay  sums  of  money, 
which  reach  in  the  aggregate  a  colossal  sum,  as  pre- 
miums to  insure  themselves  against  loss  by  Fire, 
Shipwreck,  Burglary,  Death,  Death  Duties,  against 
every  risk  which  Insurance  Companies  will  cover. 
Now  Insurance  Companies  are  not,  as  we  say,  in 
business  for  their  health.  They  find  their  business 
profitable,  and  pay  good  dividends  to  their  shareholders. 


108  SUPPLY  AND  DEMAND 

Moreover,  they  incur  a  considerable  expenditure  on 
offices,  on  clerical  staff,  on  agents,  and  the  like.  All 
these  pajnnents  must  be  defrayed  out  of  the  premiums 
they  receive;  so  that  it  is  plain  that  the  premiums 
greatly  exceed  the  expectation  of  the  risks  insured. 
The  odds  are  heavily  in  favor  of  the  Insurance  Com- 
pany— of  that  the  stupidest  person  can  have  no  shadow 
of  doubt.  Yet  we  continue  to  insure,  as  private  indi- 
viduals and  as  business  men,  and  so  far  from  being 
ashamed  of  our  proceedings  as  a  weak  and  nerveless 
folly,  v/liich  somehow  we  are  unable  to  resist,  we  blazon 
them  forth  in  the  strong  accents  of  conscious  pride. 
We  preach  insurance  to  our  neighbors  as  the  core  of 
self-regarding  duty,  and,  if  ever  we  feel  a  twinge  of 
imeasiness,  it  is  lest  we,  too,  may  have  omitted  in  some 
particular  to  practice  what  we  preach. 

The  significance  of  this  is  unmistakable.  Be  our 
psychology  what  it  may,  however  deep  and  irre- 
pressible our  taste  for  derring-do,  however  inadequate 
the  scope  which  the  dull  routine  of  modern  life  affords 
for  our  adventurous  impulses,  we  are  most  of  us  anxious 
to  avoid  the  risk  of  great  financial  loss.  We  are  very 
glad  to  find  someone  to  take  it  off  our  shoulders  if  we 
can;  so  glad  that  we  are  prepared  to  pay  him  for  the 
service,  to  pay  him  a  sum  which  covers  not  only  the 
actuarial  equivalent  of  the  risk,  but  something  sub- 
stantial over  and  above.  In  this  we  are  entirely  ra- 
tional. Our  conduct  is  justified  by  the  law  of  the  dimin- 
ishing utility  of  money,  which  was  noted  at  the  end  of 
Chapter  III.  It  would  be  plainly  foolish,  for  instance, 
to  substitute  for  the  certainty  of  an  income  of  f2500 
per  annum  an  even  chance  of  $5000  or  nothing,  since 


RISK-BEARING  AND  ENTERPRISE      109 

the  utility  to  us  of  $5000  is  not  twice  as  great  as  that 
of  $2500. 

The  majority  of  business  risks  are  not  of  a  kind 
against  which  it  is  possible  to  insure.  Insurance  com- 
panies confine  themselves  to  risks  which  are  mainly  a 
matter  of  what  we  call  objective  rather  than  subjective 
chance,  i.  e.  risks  in  respect  of  which  knowledge  of  de- 
tailed facts  peculiar  to  the  individual  case  is  of  minor 
importance.  But  such  knowledge  is  of  paramount  im- 
portance in  the  case  of  ordinary  business  risks.  If,  for 
example,  a  new  enterprise  is  to  be  undertaken,  the  spe- 
cial knowledge  and  experience  which  its  promoters 
possess  is  a  vital  factor  in  determining  their  estimate  of 
the  risk  involved.  An  outsider  with  no  special  knowl- 
edge would  necessarily  require  to  estimate  the  risk  far 
more  highly  if  we  were  to  form  a  rational  opinion  on  the 
basis  of  his  knowledge.  So  great,  indeed,  would  be  the 
risk  to  him,  that  we  can  lay  it  down  as  a  sound  maxim 
that  people  are  extremely  rash  who  invest  their  money 
in  risky  undertakings  about  which  they  know  very 
little.  This  subjective  aspect  of  business  risk  has  a 
significance  to  which  it  will  be  necessary  to  revert. 

But,  though  most  business  risks  are  not  and  cannot 
be  a  matter  for  premiums  and  policies,  the  principle, 
which  the  practice  of  insurance  illustrates,  applies  none 
the  less.  In  the  light  of  their  knowledge  and  experience, 
the  promoters  of  a  new  undertaking  must  weigh  up 
the  chances  of  failure  and  success,  though  they  will  not 
do  so  by  the  precise  methods  of  an  actuary.  They  will 
require  that  any  chances  of  serious  loss  should  be 
balanced  by  such  chances  of  exceptional  gain,  as  would 
raise  the  expectation  of  profit  well  above  the  normal 


110  SUPPLY  AND  DEMAND 

return  on  secure  investments.  The  more  risky  the 
project  seems  the  greater,  generally  speaking,  must 
be  the  expectation  of  profit  required  to  induce  people 
to  undertake  it. 

If  we  suppose  business  men  to  calculate  reasonably, 
it  follows  that  the  average  profits  in  any  industry  over 
a  long  period  of  years,  reckoning  in  the  losses  of  the 
concerns  which  disappear  altogether,  are  Kkely  to  be 
higher,  the  more  risky  is  the  industry.  Such  a  result 
will  not,  of  course,  occur  in  every  case.  Even  when  the 
calculations  are  reasonable,  they  may  be  entirely  falsi- 
fied by  the  event.  Moreover,  business  men  may  not 
calculate  reasonably  on  the  information  which  they 
have.  But,  unless  we  suppose  their  judgment  to  be  sub- 
ject to  a  prevailing  bias  in  one  direction,  i,  e.  to  be  un- 
duly optimistic  as  a  general  rule,  we  should  expect,  and 
in  any  case  they  must  expect,  profits  above  the  ordinary 
in  a  risky  industry. 

This  conclusion  is  sufficiently  important.  Far  too 
many  people,  though  they  admit  it  when  it  is  expressly 
stated  and  dismiss  it  even  as  a  tiresome  commonplace, 
are  apt  to  neglect  it  when  the  occasion  for  applying 
it  arises.  For  example,  the  great  importance  to  any 
industry  of  good  management  is  generally  recognized, 
and  the  consequent  desirability  of  paying  adequate 
salaries  to  the  managerial  staff.  The  importance 
of  securing  a  supply  of  capital  is  very  widely  recog- 
nized, and  the  practical  necessity  of  paying  a  fair  rate 
of  interest  is  thus,  however  grudgingly,  conceded. 
But  the  "residuary  profits,"  as  they  are  called,  which 
accrue  at  present  to  the  owners  of  a  business,  are  de- 
nounced   in    some   quarters   in    a   sweeping   fashion, 


RISK-BEARING  AND  ENTERPRISE      111 

which  seems  to  ignore  altogether  the  all-pervading 
element  of  risk.  People  speak  as  though  you  might 
appropriately  limit  profits  in  every  industry  to  some 
uniform  percentage  on  the  capital  employed,  with- 
out making  it  clear  whether  you  would  even  be  allowed 
to  make  up  in  good  years  for  the  losses  incurred  in 
bad.  The  effect  of  introducing  any  such  crude  device 
into  our  present  industrial  system  could  only  be  to 
paralyze  enterprises  of  an  unusually  risky  kind,  which, 
so  far  from  being  pushed  to  an  excess  at  present, 
are  more  probably  curtailed  unduly  from  the  stand- 
point of  what  is  socially  desirable.  Like  the  fixing  of  a 
low  maximum  price  for  a  commodity  it  would  cause  the 
supply  to  wither  up  and  disappear. 

§  4.  Risk  under  Large-scale  Organization.  While  this 
is  true  of  the  present  economic  system,  the  question 
is  worth  considering  whether  it  represents  a  fundamen- 
tal necessity,  whether,  for  instance,  under  our  world 
socialist  commonwealth  the  factor  of  risk-bearing  need 
play  so  important  a  part  as  it  does  in  the  actual  business 
world.  This  question  cannot  be  answered  with  a 
conclusive  simplicity;  opposing  considerations  present 
themselves,  between  which  it  is  not  easy  to  strike  a 
balance.  On  the  one  hand,  in  accordance  with  the  law 
of  averages  gains  and  losses  tend  to  cancel  out  over  a 
large  series  of  transactions,  when  reasonable  calculations 
have  been  made.  Thus  Insurance  Companies,  while 
they  take  heavy  risks  off  the  shoulders  of  pohcy-holders, 
incur  relatively  trifling  risks  themselves;  they  can 
predict  the  aggregate  sums  which  they  will  be  called 
upon  to  pay  within  a  small  margin  of  error.    In  the 


112  SUPPLY  AND  DEMAND 

same  way  it  might  seem  that  every  enlargement  of  the 
scale  of  business  would  make  for  an  automatic  insurance 
and  a  consequent  economy  of  risk;  and  thus  that  if  all 
businesses  were  comprised  in  a  single  financial  unit, 
gains  and  losses  would  cancel  out  over  so  wide  a  range 
that  the  degree  of  risk  remaining  would  be  almost 
negligible. 

This  might  indeed  happen,  if  business  risks  were 
mainly  of  that  objective  kind  in  which  the  insurance 
companies  speciaUze;  for  then  we  could  assume  that  the 
chances  of  success  or  failure  would  be  estimated  reason- 
ably. But,  in  fact,  most  business  risks,  not  being  of  this 
kind,  must  be  estimated  by  processes  of  human  judg- 
ment, which  are  very  falhble.  And  here  we  must  take 
account  of  the  law  of  averages  in  another  aspect, 
with  a  different  bearing  on  the  argument.  When  an 
industry  comprises  a  large  number  of  separate  concerns, 
and  the  decisions  accordingly  are  taken  by  many  men, 
acting  independently  of  one  another,  the  errors  of 
calculation  will  tend  to  some  extent  to  cancel  one 
another  out.  The  undue  optimism  of  one  man  will  be 
balanced  by  the  undue  pessimism  of  another;  and,  if 
there  is  no  prevailing  bias  in  either  direction,  the  errors 
of  judgment  will  not  affect  the  results  for  the  industry  as 
a  whole.  But  where  the  effective  decisions  are  taken 
by  very  few  men,  the  chances  are  far  greater  of  a  pre- 
ponderating balance  of  error  in  one  direction.  The 
risks  dependent  on  the  factor  of  human  judgment  tend 
therefore  to  increase. 

This  truth  can  be  illustrated  by  a  phenomenon  which 
is  fairly  famiUar.  It  is  recognized  by  intelligent  persons 
that  the  risks  of  speculation  in  a  particular  commodity 


RISK-BEARING  AND  ENTERPRISE      113 

market  or  stock  market  increase  more  than  propor- 
tionately to  the  scale  of  operations.  A  man  who  sets 
out  as  a  "bull"  upon  a  small  scale  can  buy  without 
sending  up  the  price  against  him  in  the  process,  and,  if 
he  decides  later  that  his  judgment  is  mistaken,  he  can 
at  any  time  cut  his  losses  and  sell  out  without  much 
difficulty.  But  a  "bull"  on  a  very  large  scale  cannot 
complete  his  purchases  except  at  a  price  which  has  been 
raised  in  consequence  of  his  own  action,  and  he  cannot 
count  on  being  able  to  "unload"  at  or  near  the  market 
price,  should  he  decide  to  do  so.  If,  accordingly,  he 
miscalculates,  he  cannot  save  himself  from  serious  loss 
as  a  smaller  man  might  do  by  a  prompt  discovery  of 
his  error.  His  difficulties  spring  from  the  fundamental 
fact  that  the  effects  of  his  calculations  are  too  great  to 
be  offset  by  those  of  the  different,  and  often  opposite, 
calculations  of  other  men. 

Upon  the  issue  whether  a  growth  in  the  size  of  the 
business  unit  is  likely  to  diminish  risk,  the  law  of 
averages  thus  cuts  both  ways.  The  risks  arising  from 
the  element  of  pure  chance  are  more  likely,  those  arising 
from  miscalculation  are  less  likely,  to  cancel  out. 
Upon  these  grounds  alone,  it  would  be  unsafe  to  con- 
clude that  there  would  be  on  balance  an -economy  of  risk 
under  any  system  of  national  or  world  sociahsm. 

§  5.  The  Entrepreneur.  There  remains,  however,  an  as- 
pect of  the  problem  which  is  perhaps  more  important 
than  those  discussed  above.  It  is  probable  that  risks 
would  be  estimated  and  undertaken  more  wisely  or 
less  wisely  under  a  different  system  of  society  or  of 
industrial  organization?    Upon  this  issue,  methods  of 


114  SUPPLY  AND  DEMAND 

precise  analysis  are  out  of  place,  but  we  may  have 
something  to  learn  from  the  emphatic  testimony  of 
tradition.  It  has  become  an  axiom  of  business  men 
that,  while  Governments  can  manage  with  more  or 
less  competence  a  safe  and  routine  business  hke  a 
Postal  Service,  their  success  would  be  unlikely  to  prove 
conspicuous  in  undertakings  where  the  element  of 
risk  is  great.  There,  it  is  said,  we  owe  everything  in 
the  past  to  the  enterprise  of  individual  men  (for  even 
joint-stock  companies  have  not  been  notable  as  pio- 
neers) adventuring  their  own  fortunes  in  accordance 
with  their  own  unfettered  judgment.  This  contention, 
however  much  we  may  desire  to  qualify  it,  has  un- 
questionably a  large  measure  of  truth,  and  the  explana- 
tion is  not  difficult  to  discover.  For  the  wise  taking 
of  risks  in  industrial  development  of  an  experimental 
character,  pecuHar  conditions  and  special  qualities 
are  required.  First,  it  is  necessary  to  envisage  dis- 
tinctly the  promising  though  risky  opportunity,  and  this 
calls  not  infrequently  for  imagination  of  a  none  too 
common  order.  Then  it  must  be  studied  with  insight 
and  expert  knowledge  and  weighed  by  processes  which 
are  as  much  intuitive  as  intellectual.  The  reasons  for  or 
against  taking  a  particular  business  risk  are  seldom  such 
as  can  adequately  be  expressed  in  terms  of  arithmetic, 
or  even  by  clear  arguments  the  soundness  of  which  is 
proportioned  to  their  logical  cogency.  The  mysterious 
faculty  of  judgment  enters  in;  and  from  mental  proc- 
esses which  defy  analysis  there  emerge  ultimately  con- 
viction and  the  will  to  act.  But  it  is  precisely  here 
that  Government  Departments  are  apt  to  fail.  It  is 
here  that  the  individual,  who  need  consult  no  one  but 


RISK-BEARING  AND  ENTERPRISE      115 

himself,  has  a  pull  over  any  form  of  organization, 
where  decisions  are  reached  by  the  method  of  debate 
and  agreement  among  a  heterogeneous  committee. 
Hence  it  is  that  we  have  come  to  regard  exceptional 
risk-taking  as  the  peculiar  province  of  individual 
enterprise.  It  is  probable  that  these  deficiencies  of 
corporate  organization  are  tending  to  diminish,  and  it 
is  an  interesting  question  how  far  it  may  be  found 
possible  to  eliminate  them  in  the  future. 

Meanwhile  the  above  considerations  have  an  im- 
portant bearing  on  the  rewards  which  can  often  be  ob- 
tained from  risky  enterprises.  The  number  of  individ- 
uals who  are  in  a  position  to  envisage  a  business 
opportunity,  and  to  assess  with  some  confidence  the 
chances  of  success  and  failure  is  very  limited.  Not  only 
must  they  possess  special  knowledge,  abihty,  imagina- 
tion, confidence  in  their  own  judgment,  and  the  ca- 
pacity to  act  on  it;  they  must  also  have  at  their  disposal 
considerable  financial  resources.  To  combine  all  these 
advantages  represents  a  union  of  circumstances  which 
is  distinctly  rare.  The  fortunate  few,  who  do  combine 
them,  are  thus  generally  able  to  extract  in  the  form  of 
profits  a  high  price  for  their  services,  a  price  which 
covers  not  only  the  strict  reward  of  risk-bearing,  and  the 
necessary  remuneration  of  their  own  senice,  but  a 
handsome  payment  for  the  special  quahties  and  ad- 
vantages which  have  been  indicated.  Profits,  moreover, 
may  vary  between  one  industry  and  another,  not  only 
in  accordance  with  the  real  risk  which  is  entailed,  but 
with  the  degree  to  which  the  supply  of  special  knowl- 
edge, etc.,  is  scarce  or  abundant. 

This  consideration  goes  a  long  way  to  explain  the 


116  SUPPLY  AND  DEMAND 

large  fortunes  which  enterprising  business  men  are 
often  able  to  amass.  It  also  throws  some  much-needed 
light  upon  the  functions  which  such  men  discharge. 
They  perform  to  a  large  extent  the  work  of  manage- 
ment; they  supply  capital  on  what  may  he  a  consider- 
able scale;  but  it  is  the  taking  of  business  risk  which  is 
perhaps  their  most  characteristic  function.  It  is  the 
union  of  these  functions  which  distinguishes  them  as 
an  essentially  different  type  from  the  salaried  manager 
who  has  invested  his  savings  in  rubber  or  in  oil.  In 
other  languages  there  is  a  specific  name  for  the  man 
who  combines  all  these  three  functions;  in  French  he 
is  called  an  "entrepreneur,"  in  German  an  ''Unter- 
nehmer."  It  is  much  to  be  regretted  that  in  Enghsh 
we  have  no  clear  corresponding  word.  The  word 
"capitalist"  is  not  uncommonly  emploj^ed  to  do  duty 
in  this  connection,  but  this  is  a  source  of  much  con- 
fusion. For  the  word  is  also  used,  and  more  appro- 
priately, to  include  all  investors,  whether  or  not  they 
are  active  business  men. 

§  6.  Rish-taking  and  Control.  But  there  is  an  allied 
confusion  of  more  importance.  We  commonly  suppose 
it  to  be  a  leading  feature  of  our  present  "capitahst 
system"  that  the  control  of  industry  rests  in  the  hands 
of  those  who  supply  the  capital.  Nor,  as  a  general 
statement,  is  this  untrue.  But  it  conceals  the  essen- 
tial point.  Strictly  speaking,  it  is  risk-taking  with 
which  control  is  associated.  The  mere  lending  of 
money  carries  with  it  no  title  to  control.  Governments 
and  municipalities  concede  no  such  title  to  the  sub- 
scribers to  their  loans;  nor  does  a  company  to  its  de- 


RISK-BEARING  AND  ENTERPRISE      117 

benture  holders.  The  shareholders'  ultimate  control 
is  based  upon  the  fact  that  they  bear  the  financial 
risks  of  the  concern.  Nor  is  this  a  matter  of  mere 
legal  form.  It  is  not  uncommon  for  ordinary  shares  to 
carry  with  them  a  greater  voting  power  than  the  pref- 
erence shares  of  a  corresponding  value.  The  principle 
which  such  arrangements  endeavor  to  express  is  clear: 
control  should  rest  with  him  who  bears  the  risk.  It 
is  with  this  principle  rather  than  with  a  mulish  in- 
sistence on  the  rights  of  property,  that  advocates  of 
"workers'  control"  and  the  like  have  got  to  reckon. 
It  is  upon  this  ground  that  (as  they  may  quite  con- 
ceivably do)  they  must  make  good  their  case. 

§  7.  General  Analysis  of  Profits.  Let  us  conclude  this 
chapter  by  clearing  the  ground  for  the  next.  Earnings 
of  management,  payments  for  risk-taking  and  for  the 
special  knowledge  and  advantages  associated  with  it, 
are  ingredients  of  the  gross  profits  of  a  business.  The 
chief  element  that  remains  is  that  of  interest  on  capital. 
Frequently,  indeed,  it  is  not  the  only  one.  As  we  saw  in 
the  last  chapter,  a  farmer  may  not  be  required  by  his 
landlord  to  pay  the  full  economic  rent  for  his  farm; 
and  he  may  therefore  make  profits  above  the  normal 
level,  above  the  ordinary  return  for  his  own  services, 
his  own  capital  expenditure,  and  the  risks  to  which 
he  is  necessarily  exposed.  In  such  a  case  the  farmer  is 
really  the  recipient,  as  we  have  already  suggested,  of 
part  of  the  economic  rent  of  the  land;  and  an  element 
of  rent  accordingly  enters  into  his  gross  profits.  But 
profits  may  include  a  surplus  element  which  may  arise 
in  a  great  variety  of  other  ways.     A  business  may 


118  SUPPLY  AND  DEMAND 

possess  some  decided  advantage  which  is  not  open  to 
competitors;  and  it  may  reap  high  profits  accordingly. 
You  can,  for  instance,  if  you  choose,  regard  the  high 
money  profits,  which,  as  was  suggested  in  Chapter  IV, 
are  Hkely  to  accrue  in  future  to  the  owners  of  pre-war 
factories,  as  a  surplus  profit  of  this  kind.  But  while,  as 
this  illustration  indicates,  the  phenomenon  of  surplus 
profits  becomes  of  very  great  importance  when  we 
seek  to  study  the  distribution  of  wealth,  it  need  not 
detain  us  here.  For  the  surplus  element  arises  only 
in  so  far  as  the  costs  of  a  business  are  lower  than  the 
marginal  costs;  and  it  is  the  marginal  costs,  which, 
with  good  reason,  we  are  now  endeavoring  to  analyze. 
The  marginal  costs  must  include  a  normal  profit,  i.e.  a 
profit  which  will  cover  earnings  of  management,  the 
reward  of  risk  and  enterprise,  interest  on  capital,  but 
nothing  further.  It  remains,  then,  only  to  consider 
this  last  element  of  interest. 


CHAPTER  VIII 

CAPITAL 

§  1.  ^  Reference  to  Marx.  Interest  is  the  price  paid 
simply  for  the  use  of  capital.  But  what  is  capital,  and 
in  what  does  its  use  consist?  What  claim  has  it  to  be 
regarded  as  an  independent  factor  of  production?  Our 
ver}^  familiarity  with  the  term,  our  habit  of  employing 
it  with  the  rich  looseness  of  every-day  life  is  an  ob- 
stacle to  the  clearness  of  thought,  which  is  again 
essential.  We  recognize,  most  of  us,  clearly  enough 
that  capital,  although  we  reckon  it  in  terms  of  money, 
consists,  like  income,  of  real  things;  factories,  machinery, 
materials  and  the  hke.  It  is  quite  obvious  that  these 
things  are  of  use,  are,  indeed,  indispensable  for  pro- 
duction; what  more  natural  than  that  capital  should 
command  a  price?  It  almost  seems  as  though  we  might 
pass,  without  further  ado,  to  a  detailed  discussion  of 
the  forces  which  determine  the  amount  of  this  price. 

But  this  account  does  not  bring  out  the  essential 
point  as  brief  reference  to  a  very  famous  controversy 
will  show.  Some  ingenious  writers  in  the  last  century, 
the  most  notable  of  whom  was  Karl  Marx,  set  out  to 
prove  that,  in  our  modern  society,  workpeople  are 
"exploited,"  robbed  of  the  ''whole  produce  of  their 
labor, "  to  the  full  extent  of  the  return  which  accrues 
to  capital.  The  argument  was  exceedingly  complex 
in  detail;  but  it  boils  down  to  this:    The  factories  and 

119 


120  SUPPLY  AND  DEMAND 

machinery  which  are  admittedly  essential  to  production 
were  themselves  produced  in  exactly  the  same  way 
as  consumable  goods.  They  were  produced  by  labor, 
working  with  the  assistance  of  nature,  and,  again,  if 
you  choose,  of  capital  in  the  form  of  further  factories, 
machinery,  etc.  But  these  further  capital  goods  can 
in  their  turn  be  regarded  as  the  product  of  labor, 
nature  and  capital;  and  so  we  can  proceed  until  it 
seems  as  though  the  element  of  capital  must  disappear 
in  the  last  analysis,  as  though  labor  and  nature  were 
the  sole  ultimate  agents  of  production,  and  the  reward 
of  capital  represented  no  more  than  the  exercise  of  the 
exploiter's  power.  In  one  form  or  another  this  argu- 
ment still  dominates  the  minds  of  a  large  proportion  of 
the  so-called  "rebels"  against  the  existing  social  order. 
If  we  are  to  meet  this  argument,  if,  which  is  perhaps 
more  important,  we  are  to  understand  the  true  nature 
of  capital,  we  cannot  rest  content  with  saying  that  it 
consists  of  factories  and  machinery,  and  that  these  are 
essential  to  the  worker.  Just  as  it  was  well  to  get 
behind  the  money  terms,  in  which  we  often  think  of 
capital,  to  the  real  goods;  so  we  have  now  to  get  behind 
the  real  goods  to  something  else.  What  this  something 
else  is,  the  first  chapter  may  have  already  done  some- 
thing to  reveal. 

§  2.  Waiting  for  Production.  Between  production 
and  consumption  there  is  an  interval  of  time.  All 
productive  processes  take  time  to  accomphsh.  The 
farmer  must  plow  the  soil  and  sow  the  seed  months 
before  he  can  reap  the  hai-vest  which  will  reward  him 
for  his  efforts.    Meanwhile,  he  must  live,  and  in  order 


CAPITAL  121 

that  he  may  live  he  must  consume.  If  he  employs 
laborers  he  must  pay  them  wages,  that  they  too  may 
consume  and  hve.  For  both  purposes  he  requires 
purchasing  power,  which  represents  of  course  command 
over  real  things;  and  if  he  has  not  sufficient  purchas- 
ing power  of  his  own,  he  must  borrow  from  someone 
else  who  has.  In  either  case  it  is  not  enough  that  the 
farmer  and  his  laborers  should  work;  no  less  essential 
is  it  that  someone  should  wait.  The  farmer  must 
wait  till  he  has  sold  his  crops,  both  for  the  reward  of 
his  own  labor  and  for  the  repayment  of  the  wages  he 
advances  in  the  meantime  to  his  laborers.  Or,  if  he 
cannot  afford  to  wait,  and  borrows  in  anticipation  of 
the  harvest,  then  the  lender  must  wait,  mitil  the  farmer, 
having  sold  his  crop,  is  able  to  repay  him.  Thus  the 
period  of  time  involved  in  all  production  gives  rise  to 
a  demand  for  waiting,  which  someone  or  other  must 
supply,  if  the  production  is  to  take  place.  It  is  this 
waiting  which  is  the  essential  reality  underlying  the 
phenomena  of  capital  and  interest.  It  is  really  this 
which  constitutes  an  independent  factor  of  production, 
distinct  from  labor  and  nature,  and  equally  necessary. 

§  3.  Waiting  for  Consumption.  But  let  us  carry  the 
argument  a  step  s  further.  After  the  farmer  has  sold 
his  crops,  there  are  many  stages  through  which  they 
must  pass,  at  each  of  which  more  waiting  is  required, 
before  they  reach  the  ultimate  consumer.  But  then  the 
waiting  is  at  an  end. 

This,  however,  is  by  no  means  the  case  with  a  great 
number  of  commodities.  Let  us  take  the  case  of  a 
speculative  builder.    While  he  is  building  a  house  he. 


122  SUPPLY  AND  DEMAND 

like  the  farmer,  must  wait  (or  find  someone  t-o  wait 
on  his  behalf,  for  his  own  reward,  and  for  the  repayment 
of  his  expenditure  on  wages  and  materials.  But,  after 
the  house  is  built,  if  he  lets  it  to  a  tenant  for  an  annual 
rent,  his  waiting  is  far  from  over.  Not  until  many  years 
have  passed  will  the  rent  pajmaents  add  up  to  a  sum 
which  equals  or  exceeds  his  outlay.  He  may,  of  course, 
sell  the  house,  and  thus  bring  his  waiting  to  an  end. 
But  then  the  purchaser  must  wait,  no  matter  whether 
or  not  he  is  the  occupier.  For  no  one  would  consider 
the  use  of  a  house  for  a  day,  a  month,  or  a  year  as  an 
adequate  return  for  the  price  it  cost  to  buy.  The 
occupier-owner  pays  for  the  prospect  of  its  use  for  a  long 
and  perhaps  indefinite  number  of  years  ahead,  and  he 
must  wait  to  enjoy  the  benefits  for  which  he  pays 
now  in  full.  Waiting  is  as  inherent  in  the  consumption 
of  durable  things  as  it  is  in  all  production. 

Now  most  industries  are  consumers  of  durable  things 
of  a  very  expensive  kind.  Here  we  come  back  to  the 
factories  and  machinery  which  ordinarily  spring  to  our 
mind  at  the  mention  of  the  word  capital.  Not  merely 
does  the  construction  of  these  things  involve  waiting; 
their  consumption  involves  waiting  on  a  vastly  larger 
scale.  Just  as  with  a  house,  many  years  must  elapse 
before  their  derived  utility  can  even  approximate  to 
their  purchase  price.  It  is  mainly  to  supply  the  waiting 
involved  in  the  consumption  of  such  durable  goods, 
that  a  typical  joint-stock  company  issues  shares  for 
pubHc  subscription.  The  waiting  required  to  cover  the 
period  of  time,  which  its  own  productive  process  re- 
quires, is  largely  supplied  by  means  of  bank  overdrafts 
or    other    forms    of    short-period    borrowing.      More 


CAPITAL  123 

strictly,  fixed  capital  represents  the  waiting  involved  in 
the  consumption  of  durable  things;  circulating  capital 
the  waiting  involved  in  current  production. 

This  distinction  loses  its  sharpness  when  we  consider 
not  the  affairs  of  a  particular  business,  but  the  industrial 
system  as  a  whole.  Then  the  period  of  time  involved 
in  the  consumption  of  durable  instruments  falls  into 
place  as  part  of  the  time  required  for  the  production 
of  the  ultimate  consumers'  goods.  We  can  even,  per- 
haps, conceive  of  an  "average  period  of  production  "  for 
industry  and  commerce  as  a  whole;  and  this  conception 
is  not  without  its  uses.  For  it  serves  to  bring  out  the 
fact  that  the  period  of  consumption,  and  the  period  of 
production  in  the  narrower  sense,  are  only  two  aspects 
of  the  same  fundamental  thing,  the  interval  of  time 
which  elapses  between  work  and  the  utility,  which  is 
its  ultimate  purpose.  It  serves,  moreover,  to  make  clear 
that  anything  which  lengthens  this  interval  of  time 
increases  the  demand  for  waiting,  or  in  other  words, 
the  demand  for  capital;  and,  conversely,  that  anything 
which  shortens  this  interval  diminishes  the  demand 
for  capital. 

§  4.  Capital  not  a  Stock  of  Consumable  Goods.  But 
the  distinction  between  the  two  forms  of  waiting, 
though  not  fundamental,  is  none  the  less  worth  noting. 
It  enables  us  to  keep  our  theory  in  conformity  with 
fact,  to  look  at  the  phenomenon  of  capital  the  right 
way  up;  and  it  is  easy,  if  we  are  not  careful,  to  slip 
into  the  habit  of  looking  at  it  upside  down.  People 
sometimes  speak  as  though  the  commodities  which 
constitute  our  capital,  instead  of  being  mainly,  as  our 


124  SUPPLY  AND  DEMAND 

plain  sense  tells  us  that  they  are,  factories,  machinery 
and  other  durable  instruments,  were  rather  a  store  or 
stodz  of  immediately  consumable  goods.  The  argument 
takes  the  following  form.  It  is  consumers'  goods, 
things  like  food  and  clothes,  which  the  farmer,  the 
builder  and  their  workpeople  consume  while  they  are 
working.  To  enable  them  to  work,  therefore,  it  is  vital 
that  such  things  should  not  in  the  past  have  been  con- 
sumed as  soon  as  they  were  made;  part  of  them  must 
have  been  saved,  and  carried  forward  for  future  use. 
Furthermore,  the  longer  the  time  that  the  work  on 
which  people  are  now  engaged  takes  to  yield  its  product, 
the  larger  must  be  this  store  of  consumers'  goods.  For 
these  products,  when  they  are  completed,  will  serve 
(taking  society  as  a  whole)  to  replace  the  store  which  in 
the  meantime  is  being  used  up,  so  that  the  longer  this 
replacement  takes,  the  larger  must  be  the  initial  store. 
Conversely,  the  larger  the  store  of  consumers'  goods 
available,  the  more  distant  is  the  future  for  which  we 
can  afford  to  work.  It  is  thus  the  store  or  stock  of 
consumers'  goods  which  represents  our  real  capital; 
for  it  is  the  magnitude  of  this  store  which  determines 
how  far  we  can  devote  our  energies  to  purposes  which 
are  remote  in  time. 

Now  this  is  pure  mysticism.  Regarded  literally, 
it  is  in  direct  conflict  with  the  facts.  The  processes 
of  industry  are  fairly  regular  and  continuous.  At  any 
moment,  large  quantities  of  consumers'  goods  of  almost 
every  kind  are  on  the  point  of  completion ;  at  the  same 
moment  equally  large  quantities  are  consumed.  The 
things  which  we  buy  were  finished,  very  likely,  only 
recently;  or,  if  in  fact  they  have  lain  idle  for  some 


CAPITAL  125 

time  in  stock,  there  is  nothing  essential  or  at  all  helpful 
in  that  fact.  It  represents  rather  a  defect — a  malad- 
justment which  should  be  rectified.  Even  many  kinds 
of  agricultural  produce  do  not  need  to  be  carried  for- 
ward from  one  year  to  another,  for  they  are  produced  in 
many  parts  of  the  world,  where  the  seasons  come  at 
different  periods  of  the  year.  It  is  conceivable,  there- 
fore, that  we  might  consume  all  non-durable  things 
the  moment  they  were  ready,  and  the  degree  to  which 
we  approximate  to  this  ideal  is  a  mark  of  the  efficiency 
of  our  economic  system.  A  large  store  of  consumable 
goods  is  thus  not  a  fundamental  necessity  of  a  prosper- 
ous society. 

What  is  necessaiy  is  plainly  the  power  to  produce 
these  things  in  large  quantities  as  they  are  required. 
And  this  power  is  furnished  by  the  durable  instruments 
of  production,  which  we  thus  rightly  regard  as  the  true 
representatives  of  modern  capital.  If  it  is  argued  that 
this  power  to  produce  consumable  goods  may  be  re- 
garded as  being  in  effect  a  store  of  consumable  goods,  it 
must  be  sternly  replied  that  this  is  the  language  of 
symboKsm,  not  of  science,  and  that  symbolism  is  highly 
dangerous  in  this  connection.  The  false  conception  of 
capital  as  essentially  a  store  of  consumers'  goods  has 
led  and  still  leads  to  many  serious  fallacies.  It  was 
this  that  gave  rise  to  the  notorious  doctrine  of  the 
Wages  Fund;  the  notion  that  the  sum  which  can  at  any 
time  be  paid  in  wages  is  equal  to  the  quantity  of  capital, 
alias  consumable  goods,  which  happens  to  exist.  To 
this  day  it  blocks,  with  an  undergrowth  of  obscurantist 
controversies,  the  way  to  a  straightforward  account 
of  the  problem  of  trade  cycles. 


126  SUPPLY  AND  DEMAND 

§  5.  The  Essence  of  Waiting.  But  it  is  with  positive 
conclusions  that  we  must  here  concern  ourselves. 
What  is  the  essence  of  this  waiting,  as  we  have  called 
it?  What  are  its  results  from  the  point  of  view  of  the 
community?  The  individual,  who  saves  and  lends, 
waits  in  the  obvious  sense  that  he  postpones  consump- 
tion. He  foregoes  his  right  to  purchase  now  a  quantity 
of  consumers'  goods  in  consideration  of  the  prospect 
of  purchasing  a  larger  quantity  of  such  things  in  the 
future.  From  the  standpoint  of  the  whole  community, 
there  is  a  similar  postponement  of  consumption,  though 
it  need  not  commence  so  soon.  The  store  of  consum- 
able goods  is  what  it  is :  the  quantity  of  goods  in  process 
of  manufacture,  which  will  shortly  be  coming  forward, 
is  also  what  it  is.  For  some  time,  therefore,  a  sudden 
access  of  saving  cannot  affect  the  quantity  of  goods 
available  for  consumption;  and  if,  in  fact,  they  should 
be  consumed  less  rapidly,  that  will  represent  an  unfor- 
tunate defect,  not  an  essential  condition  of  a  smoothly 
working  sj'^stem.  The  necessary  consequence  comes 
later.  The  increased  saving  will  cause  labor,  materials, 
land,  agents  of  production  generally,  to  be  devoted 
to  distant  purposes.  Men  will  be  set  to  work  producing 
durable  goods,  largely  durable  instruments  of  produc- 
tion like  ships  or  railways  or  factories  or  plant.  If  the 
increased  saving  is  considerable,  the  labor,  materials, 
etc.,  required  for  these  purposes  will  be  withdrawn 
even  under  our  present  system,  as  under  a  smoothly 
working  system  they  clearly  must  be,  from  the  pro- 
duction of  other  and  more  immediately  consumable 
things.  Hence,  some  time  later,  the  suppUes  of  con- 
sumable things  will  be  diminished,  while  at  a  later 


CAPITAL  127 

period  still  they  will  be  more  than  correspondingly- 
increased  as  the  result  of  the  assistance  of  the  new 
durable  instruments.  That  is  the  essence  of  saving 
from  the  social  standpoint.  An  early  future  is  sacrificed 
to  a  more  remote  future.  The  aggregate  consumable 
income  of  the  present  is  unaffected;  the  aggregate  con- 
sumable income  of  the  near  future  is  actually  dimin- 
ished; it  is  not  until  at  least  some  years  later  that  the 
aggregate  consumable  income  is  increased. 

§  6.  Individual  and  Social  Saving.  This  conclusion 
is  important:  but  there  is  an  obvious  misinterpre- 
tation against  which  it  will  be  well  to  guard.  It  is 
customary  for  social  moralists  to  preach  thrift  and 
saving  as  a  public  duty,  and  to  impart  to  their  appeals 
a  special  note  of  urgency  in  times  like  the  present, 
when,  as  the  result  of  the  havoc  of  the  war,  destitution 
is  widespread  over  Europe.  Now  obviously  these  ad- 
visers do  not  mean  to  recommend  something  which 
will  impoverish  the  world  next  year  and  the  year  after 
and  the  benefit  of  which  will  accrue  only  in  a  distant 
future:  it  is  the  immediate  urgency  of  the  world's 
needs  which  is  rather  the  substance  of  their  case.  Nor 
would  it  be  right  to  conclude  that  these  wise  men  are 
the  victims  of  a  delusion,  and  advocate  a  course,  the 
consequence  of  which  they  do  not  imderstand.  The 
explanation  of  the  paradox  is  simple.  The  more  the 
community  as  a  whole  saves  now,  the  less  in  the  near 
future  will  be  the  aggregate  consumable  income  of  the 
whole  community:  but  not  of  the  remainder  of  the 
community,  exclusive  of  the  savers.  It  is  the  saver 
who  must  wait,  whose  consumption  must  be  post- 


128  SUPPLY  AND  DEMAND 

poned  to  perhaps  a  distant  future;  but  at  no  time  does 
his  saving  result  in  a  smaller  income  of  consumable 
goods  for  other  people.  The  aggregate  consumable 
income  of  the  near  future  will  be  diminished,  but  it 
may  be  better  distributed,  and  it  may  consist  of  things 
of  a  different  kind.  For  consumers'  goods,  we  must 
remember,  comprise  champagne  and  motor  cars  as 
well  as  food  and  clothes;  and,  if  a  rich  man  saves,  it 
may  be  purely  articles  of  luxury,  the  production  of 
which  will  shortly  be  diminished.  Moreover,  if  his 
saving  has  the  effect  of  transferring  purchasing  power 
to  impoverished  people,  Hke  those  in  Central  Europe, 
it  will  not  be  devoted  to  a  distant  future;  it  will  very 
likely  be  devoted  to  quite  immediate  ends.  In  other 
words,  it  may  not  result  in  any  "creation  of  capital"; 
it  may  not  represent  any  saving  on  the  part  of  the 
community  as  a  whole.  A  relatively  rich  man  waits, 
and  a  relatively  poor  man  anticipates  his  income  to  a 
corresponding  extent;  and  it  is  precisely  this  that  is  so 
urgently  desirable  in  a  time  of  widespread  poverty  and 
chaos. 

This  is  no  matter  of  hair-spUtting,  and  making 
plain  things  obscure.  While  it  is  always  better  for  the 
rest  of  us  that  an  individual,  who  can  afford  to  save, 
should  save  rather  than  spend  (though  it  might  be 
better  for  us  still  if  we  could  have  his  money  to  spend 
ourselves)  and  while  this  is  the  more  important  the 
greater  is  the  poverty  which  generally  prevails;  yet, 
as  a  community  we  cannot  save  so  much,  we  ought 
not  to  save  so  much,  when  we  are  impoverished  as 
when  we  are  prosperous.  It  is  vital  to  appreciate  this 
truth,  because,  as  we  shall  see,  by  no  means  all  the 


CAPITAL  129 

saving  of  the  world  is  done  by  individuals.  There  are 
many  forms  of  "collective  saving,"  which  take  place 
in  actual  fact;  still  more  which  we  are  often  urged  to 
undertake.  And  it  is  of  practical  importance  to  reahze 
that  the  very  considerations,  which  call  most  urgently 
for  individual  thrift,  forbid  a  great  indulgence  in  such 
projects.  A  time  of  national  poverty  is  not  a  time 
when  it  is  suitable  for  the  State  to  embark  on  large 
schemes  of  capital  development:  we  require  our  re- 
sources for  more  immediate  ends.  Faced  with  such 
problems,  our  practical  sense  may  no  doubt  suffice  to 
keep  us  straight;  but  it  is  apt  to  do  so  at  the  expense 
of  a  complete  inversion  of  the  real  issues.  If,  for  in- 
stance, we  call  for  Governmental  retrenchment  on 
what  we  deem  extravagant  pohcies  of  housing  and 
education,  we  usually  speak  as  though  they  represented 
the  profligacy  of  a  spendthrift  as  contrasted  with 
the  saving  that  is  indispensable.  The  truth  is  rather 
that  these  pohcies  represent  a  saving,  an  investment  for 
future  purposes,  which  may  conceivably  be  greater 
(this  must  not  be  taken  as  representing  my  personal 
opinion)  than  the  community  can  properly  afford. 
This  is  another  instance  of  what  I  mean  by  looking 
at  the  problem  of  capital  the  right  waj'-  up. 

§  7.  The  Necessity  of  Interest.  It  is  only  now  that 
we  are  in  a  position  to  appreciate  the  true  functions 
of  a  rate  of  interest,  and  the  nature  of  its  claims  to  be 
regarded  as  a  "real  cost."  Interest,  it  is  sometimes 
said,  is  necessary  to  provide  for  the  future.  It  is  far 
more  certain  that  interest  is  necessary  to  provide  for 
the  present.    It  is  a  matter  of  legitimate  doubt  how  far 


130  SUPPLY  AND  DEMAND 

it  is  necessary  to  yay  interest  to  secure  a  supply  of 
capital;  there  is  no  doubt  at  all  that  it  is  necessary  to 
charge  interest  to  limit  the  demand  for  it.  As  we  saw  in 
Chapter  I,  a  world  socialist  commonwealth  would 
require  to  retain  a  rate  of  interest,  if  only  as  a  matter 
of  bookkeeping,  in  order  to  choose  between  the  various 
capital  undertakings  that  were  technically  possible. 
And  this  is  the  primary  fimction  which  the  fate  of 
interest  fulfils  in  our  present-day  society.  It  separates 
the  sheep  from  the  goats.  It  serves  as  a  screen,  by 
means  of  which  capital  projects  are  sifted,  and  through 
which  only  those  are  allowed  to  pass  which  will  benefit 
the  future  in  a  high  degree.  For  this  essential  purpose 
it  is  hard  to  imagine  how  a  better  instrument  could  be 
devised. 

§  8.  The  Supply  of  Capital.  Let  us  dwell  for  a  moment 
on  this  image  of  a  screen,  or  sieve.  One  condition  of  a 
good  sieve  is  that  its  meshes  should  all  be  of  the  same 
size.  This  condition  the  rate  of  interest  almost  perfectly 
fulfils.  But  it  is  also  important  that  the  meshes  should 
be  of  the  right  size.  Whether  this  is  true  of  the  actual 
rate  of  interest  is  a  far  more  doubtful  matter.  It  is, 
indeed,  plain  that  it  is  not  altogether  devoid  of  merit  in 
this  respect.  In  times  of  general  world  poverty,  like 
those  which  follow  upon  a  great  war,  it  is  desirable,  as 
has  been  argued,  that  more  of  our  productive  resources 
should  be  devoted  to  immediately  useful  purposes,  and 
a  smaller  portion  dedicated  to  a  distant  future.  This 
readjustment  the  rate  of  interest  helps  to  bring  about. 
For  it  rises  to  a  higher  level,  and  there  is  accordingly 
a  strong  inducement  to  all  manufacturers  and  traders 


CAPITAL  131 

to  economize  their  use  of  capital,  and  thus  to  set  free 
productive  resources  for  more  urgent  needs.  But, 
while  the  meshes  of  the  sieve,  as  it  were,  contract  in 
times  when  it  is  desirable  that  they  should  contract, 
we  have  no  reason  for  supposing  that  they  will  contract 
in  just  the  degree  that  is  desired,  neither  more  nor  less; 
or,  indeed,  that  at  any  time  they  approximate  to  the 
right  size.  We  in  the  twentieth  centuiy  owe  much 
of  the  material  wealth  that  we  enjoy  to  the  fact  that 
over  the  last  century  men  saved  as  largely  as  they 
did.  But  our  natural  gratitude  should  not  restrain 
us  from  doubting  whether  they  were  really  well  advised 
to  do  so.  If  we  ask  the  question  how  they  managed  to 
do  so,  our  doubts  are  deepened.  For  first  place  among 
the  explanations  must  be  assigned  to  the  inequality 
in  the  then  distribution  of  wealth.  It  was  because 
many  men  in  England  were  rich  enough  to  save  that  our 
railways  were  built,  and  the  resources  of  new  Continents 
were  opened  up.  But  England,  a  century  or  even  half  a 
century  ago,  was  not  really  a  rich  community.  And  if 
the  national  income  in  those  days  had  been  distributed 
more  evenly  among  the  people,  can  we  doubt  that  they 
would  have  spent  a  far  larger  proportion  of  it  on 
inmiediate  needs;  can  we  doubt  that  they  would  have 
been  right  to  do  so?  We  may  rather  doubt,  in  view 
of  the  reactions  of  poverty  on  physical  and  mental 
efficiency,  on  social  harmony,  even  possibly  on  popula- 
tion, whether  we  to-day  would  have  been  really  injured 
as  much  as  might  appear.  How,  then,  can  we  suppose 
that  the  sum  of  the  amounts  which  it  suits  individuals 
to  save  will  bear  any  close  relation  to  the  resources 
which  the  community  can  properly  devote  to  future 


132  SUPPLY  AND  DEMAND 

ends?  Are  we  to  regard  an  unjust  distribution  of  wealth 
as  a  mysterious  dispensation  of  Providence  for  securing 
perfect  harmony  between  the  future  and  the  present? 
The  point  need  not  be  labored  further.  There  are  no 
grounds  for  assuming  that  we  save,  as  a  community, 
even  roughly  what  we  ought  to  save.  If  we  wish  to 
believe  we  do,  we  must  turn  for  support  from  economics 
to  theology. 

It  is  important  to  be  clear  upon  this  issue  in  order  to 
distinguish  it  from  another,  with  which  it  sometimes 
seems  to  be  confused.  This  is  the  question,  briefly 
outlined  in  Chapter  II,  of  the  effect  of  changes  in  the 
rate  of  interest  on  the  supply  of  capital.  As  was  there 
indicated,  there  are  good  reasons  for  supposing  that  a 
fall  in  the  rate  of  interest  would  induce  some  people 
to  save  more,  and  conversely.  But  the  balance  of  prob- 
ability is  in  favor  of  the  conclusion  that  the  net  effect 
of  changes  in  the  rate  of  interest,  though  perhaps  slight, 
is  usually  of  the  more  ordinary  kind.  The  decisive  argu- 
ment in  this  connection  is  the  fact,  upon  which  we  have 
just  touched,  that  savings  are  supplied  largely  by  people 
who  are  relatively  rich,  and  who  become  richer  when  the 
rate  of  interest  rises.  For  at  this  point  it  is  necessary  to 
be  careful.  It  is  easy  to  slide  from  the  above  conclu- 
sion into  an  argument  of  the  following  kind.  A  higher 
rate  of  interest  leads  to  more  saving;  it  is  thus  necessary 
to  evoke  more  saving;  it  is  thus  required  as  an  incentive 
to  induce  people  to  incur  the  sacrifice  of  waiting;  this 
sacrifice  represents  the  "real  cost"  for  which  interest 
is  paid. 

This  terminology  of  incentive,  inducement  and 
sacrifice  is  of  very  dubious  validity.    A  rich  man,  who 


CAPITAL  133 

is  made  richer  by  a  rise  in  the  rate  of  interest,  will 
probably  save  more,  but  it  will  be  rather  because  he 
has  become  richer  than  because  he  is  tempted  by 
the  higher  rate:  and  the  less  we  talk  about  his  sacrifice 
the  better.  Nor  is  it  clear  that  the  attraction  of  a  high 
rate  of  interest  is  an  operative  factor  on  the  mind  of  a 
man  to  whom  saving  means  a  real  sacrifice  of  mimediate 
comfort  or  enjoyment.  Certainly  it  is  only  one  among 
many  factors,  and  seldom  an  important  one.  A  really 
poor  man  will  think  not  so  much  of  the  annual  income 
which  will  accrue  from  his  savings,  as  of  the  capital 
sum  upon  which  he  or  his  family  can  fall  back  if  a 
rainy  da^^  should  come.  And  for  this  purpose  he  might 
save  as  much  as  he  saves  now,  even  if  there  were  no 
interest  to  be  obtained  thereby.  He  might  even  be 
prepared  to  lend  what  he  had  saved,  at  least  to  banks 
(a  deposit  with  a  bank  is  in  effect  a  loan),  for  the  mere 
advantage  of  safe  custody.  The  people  who  save  rather 
for  the  sake  of  the  capital  sum  that  can  be  realized  than 
for  that  of  the  annual  interest  are  very  numerous,  and 
probably  include  many  men  in  receipt  of  quite  consider- 
able earned  incomes.  Moreover,  those  who  consider 
mainly  the  future  annual  income  which  their  savings 
will  jaeld  them,  are  usually  more  concerned  with  its 
absolute  amount  than  with  the  ratio  it  bears  to  the 
amount  they  must  save  in  order  to  acquire  it.  For  this 
reason,  as  has  been  often  recognized,  they  may  save 
less  when  the  rate  of  interest  rises,  since  a  smaller 
quantity  of  savings  will  insure  to  them  the  future  an- 
nual income  they  desire  to  obtain.  There  is  no  need  to 
be  dogmatic  upon  any  of  these  points.  The  psychology 
of  saving  is  both  complex  and  obscure.    Our  conclusion 


134  SUPPLY  AND  DEMAND 

must  be  the  negative  one  that  we  have  insufficient 
evidence  to  warrant  the  assertion  that  the  particular 
rate  of  interest  which  happens  to  prevail  is  a  measure  of 
the  sacrifice  involved  in  saving,  even  in  the  case  of  what 
we  might  regard  as  the  "marginal  saving."  And,  if 
we  cannot  assert  this,  we  must  be  careful  not  to  assume 
it  as  the  basis  of  other  arguments,  or  as  part  of  a  general 
analysis  of  price  or  exchange  value. 

It  is  of  some  interest  to  observe  that  the  difficulties 
which  our  world  socialist  commonwealth  would  en- 
counter if  it  attempted  to  dispense  with  the  rate  of 
interest,  would  not  necessarily  include  that  of  obtaining 
a  supply  of  capital.  It  might,  indeed,  not  find  it  easy 
to  determine  the  proportions  in  which  it  should  allocate 
its  productive  resources  between  immediate  and  distant 
ends.  Our  present  system  cannot  be  said  to  have  evolved 
satisfactory  principles  for  the  solution  of  this  question; 
and  the  socialist  commonwealth  would  have  to  work 
out  its  own.  solution.  But  when  it  directed  that  labor 
and  materials  should  be  devoted  to  purposes  of  long- 
period  utility,  there  would  be  an  automatic  collective 
saving,  of  v/hich  no  one  would  be  conscious  as  an 
individual  sacrifice.  Even  at  the  present  time,  our 
capital  is  not  supplied  entirely  by  the  savings  of  indi- 
viduals, but  to  an  extent,  which  though  quite  incalcu- 
lable is  yet  certainly  considerable,  by  involuntary  saving 
of  an  essentially  similar  type  to  the  above. 

§  9.  Involuntary  Saving.  When  a  municipality  embarks 
on  a  municipal  tramways  scheme  or  any  other  industrial 
enterprise,  and  pays  off  by  means  of  a  sinking-fund 
the  capital  which  it  borrows  in  the  first  instance,  the 


CAPITAL  135 

proceeding  amounts,  as  the  defenders  of  municipal 
trading  have  rightly  claimed,  to  a  compulsory  and 
unconscious  saving  on  the  part  of  the  citizens.  Their 
consumption  has  been  postponed  willy-nilly  as  the 
result  of  the  increased  rates  or  the  high  charges  which 
they  have  had  to  pay;  and,  when  the  subscribers  to 
the  original  loan  have  been  paid  oJEf,  the  capital  of  the 
community  is  enhanced  to  the  extent  of  that  loan. 
Central  governments  might  similarly  increase  the  supply 
of  capital  by  devoting  annual  revenue  to  capital  pur- 
poses; though  their  actual  record,  as  it  happens,  is 
mainly  of  a  different  kind.  But  what  is  chiefly  a  possi- 
bility in  the  case  of  Governments  has  actually  been 
carried  out  on  an  enormous  scale  by  other  institutions. 
The  development  of  the  joint-stock  company  system  has 
introduced  a  new  factor  into  the  problem  of  the  supply 
of  capital,  which  is  of  immense  though  but  dimly 
perceived  importance.  The  directors  of  a  company 
are  technically  no  more  than  the  servants  of  the  share- 
holders. It  is  the  profit  of  the  shareholders  that  it 
is  the  directors'  duty  to  promote  with  a  single  mind, 
and  the  whole  capital  of  the  concern,  including  its 
reserves  both  open  and  concealed,  is  the  shareholders' 
exclusive  property.  But  realities  have  a  way  of  differ- 
ing from  forms,  and  just  as  in  political  affairs  it  is  com- 
mon to  regard  the  State  as  a  very  different  thing  to  the 
people  who  compose  it,  as  a  sublime  entity  with  a  sepa- 
rate existence  of  its  own,  so  directors  are  apt  to  distin- 
guish between  the  company  and  the  shareholders.  It  is 
the  company  to  which  they  owe  allegiance.  To  pay 
away  in  dividends  to  shareholders  money  which  they 
could  employ  in  extending  the  business  or  strengthen- 


136  SUPPLY  AND  DEMAND 

ing  the  position  of  the  company  appears  to  some  direct- 
ors a  necessity  hardly  less  unpleasant  than  an  increased 
wages  bill,  or  an  Excess  Profits  Duty.  Concessions  must 
indeed  be  made  to  the  shareholders'  rapacity :  but 
when  something  has  been  done  in  this  direction,  dust 
can  easily  be  thrown  in  their  not  very  observant  eyes. 
Reserves,  which  within  limits  are  a  necessity  of  sound 
finance,  can  be  accumulated  beyond  those  limits,  and, 
when  the  further  limits  of  an  extreme  but  just  argu- 
able consei-vatism  have  been  passed,  there  remain  the 
innumerable  devices,  known  to  every  resourceful 
Board,  of  hidden  reserves,  the  secret  of  which  is  un- 
menaced  by  the  meager  information  of  a  balance-sheet. 
In  all  this  the  shareholder,  as  the  directors  occasionally 
assure  themselves,  has  no  real  grievance,  for  he  will 
gain  in  the  long  run,  from  the  appreciation  in  the  capital 
value  of  his  shares,  all  and  perhaps  more  than  all  that 
he  foregoes  in  the  meantime  in  the  way  of  dividends. 

In  the  long  run  the  shareholder  is  not  injured;  but 
in  the  meantime  he  is  in  effect  compelled,  without 
any  consciousness  of  the  proceeding,  to  save  and  to 
reinvest  in  the  company  a  portion  of  the  dividends, 
which  he  might  otherwise  have  spent.  The  reserves 
which  are  accumulated  are  not  allowed  to  lie  idle: 
they  are  employed  either  in  what  are  really  capital 
extensions  of  the  business,  or  in  the  purchase  of  outside 
securities,  and  in  either  case  they  represent  an  increase 
in  the  total  supply  of  capital.  The  principal  which 
these  proceedings  represent  is  capable  of  indefinite 
extension. 

But  however  possible  it  might  be  to  secure  a  supply 
of  capital  without  the  inducement  of  a  rate  of  interest. 


CAPITAL  137 

that  rate  is  indispensable  for  dealing  with  the  demand. 
It  is  no  good  saying,  "Three  per  cent  seems  a  fair  rate 
of  interest;  let  us  try  and  limit  it  to  that."  Given 
the  amount  of  savings  which  are  supplied,  the  rate  of 
interest  must  be  allowed  to  reach  whatever  figure 
is  necessary  to  confine  the  demand  to  that  amount. 
Given  the  quantity  of  resources  which  you  have  avail- 
able for  future  needs,  the  meshes  of  the  sieve  must  be 
made  as  narrow  as  is  necessary  to  confine  the  projects 
that  pass  through  within  those  limits.  And  so,  indeed, 
it  becomes  necessary  for  any  particular  business  to  pay 
for  its  capital  interest  at  the  market  rate,  not  so  much 
to  secure  the  saving  of  it  as  to  secure  its  allocation  from 
the  common  pool. 

§  10.  Interest  and  Distribution.  It  is  unavoidable  that 
this  interest  should  accrue  to  whoever  it  is  that  sup- 
plies the  capital.  If  the  capital  were  supplied,  as  it 
might  conceivably  be,  collectively  by  the  community, 
the  interest  would  accrue  to  the  community,  and  all 
would  be  well.  But  as  things  are,  the  capital  is  supplied 
mainly  by  the  savings  of  individuals,  and  largely  by 
individuals  confined  to  a  relatively  narrow  class.  The 
profits  of  Capital  have  thus  a  vital  influence  on  the 
very  serious  matter  of  the  distribution  of  wealth  be- 
tween social  classes.  Now,  as  experience  shows,  there 
is  no  element  in  profits  which  is  capable  of  such  radical 
change  in  so  short  a  space  of  time,  as  is  the  rate  of 
interest.  Even  before  the  war  it  had  become  hard  for 
people  in  Great  Britain  to  reahze  that  3  per  cent  Consols 
had  stood  at  114  as  late  as  1896.  "How  blest,"  wrote 
two  cynical  satirists  of  society  in  the  same  period: 


138  SUPPLY  AND  DEMAND 

"'How  blest  the  prudent  man,  the  maiden  pure, 
Whose  income  is  both  ample  and  secure. 
Arising  from  ConsoUdated  Three 
Per  cent  Annuities,  paid  quarterly."  i 

It  is  impossible  to  read  those  lines  now  without  a 
sense  of  irony,  different  from  that  which  they  were 
intended  to  convey. 

Not  only  is  the  rate  of  interest  now  double  what  it 
was  a  generation  ago;  we  have  no  good  reason  to  suppose 
that  the  present  high  level  will  quickly  be  reduced. 
The  havoc  of  the  war,  of  which  the  widespread  poverty 
of  Europe  and  the  huge  debts  of  Governments  are  but 
two  different  aspects,  makes  it  almost  inevitable  that 
the  rate  should  rule  high  in  the  present  decade.  This 
cannot  but  exercise  a  profound  influence,  of  a  most 
disquieting  character  on  the  general  level  of  profits, 
and  to  a  lesser  extent  (for  here  we  must  allow  for  the 
effects  of  high  taxation)  on  the  distribution  of  real  wealth 
between  social  classes.  Here  we  are  on  the  threshold 
of  tremendous  issues.  We  almost  feel  the  earth  quake 
beneath  our  feet.  We  hear  the  muffied  roar  of  far- 
reaching  social  controversy: 

"And  'mid  this  tumult  Kubla  heard  from  far 
Ancestral  voices  prophesying  war." 

1  Narcissus,  by  Samuel  Butler  and  Henry  Festing  Jones. 


CHAPTER  IX 

LABOR 

§  1.  ^  Retrospect  on  Laissez-faire.  When,  a  century 
and  a  half  ago,  the  foundations  were  being  laid  in  the 
Western  world  of  systematic  economic  theory,  the 
public  attention  was  much  occupied  with  a  subject, 
which  indeed  has  not  ceased  to  hold  it:  that  of  the 
failings  of  Governments.  The  general  interest  in  that 
topic  was  shared  by  the  pioneers  of  economic  thought, 
of  whom,  in  Great  Britain,  Adam  Smith  was  the  most 
notable.  It  was  indeed  their  practical  concern  with  the 
concrete  economic  issues  of  the  day  which  very  natu- 
rally gave  the  impetus  to  their  scientific  quest.  It  was 
hardly  less  natural  that  they  should  have  expressed 
their  opinions  on  these  concrete  issues  with  considerable 
emphasis. 

Now  the  keynote  of  their  practical  conclusions  was 
that  Governments  were  doing  immense  mischief  by 
meddling  with  a  great  many  matters,  which  they  would 
have  done  better  to  leave  alone.  In  this  they  were  in 
general  agreement  with  one  another;  incidentally — 
let  there  be  no  mistake  about  it — they  were  right.  But, 
as  invariably  happens  in  public  controversy,  their 
opinions  became  crystallized  in  a  compact  formula,  or 
cry,  with  unduly  sweeping  implications.  This  was  the 
cry  of  ^'laissez-faire.'"  Let  Governments  preserve  law 
and  order;  and  leave  the  economic  sphere  alone.    The 

139 


140  SUPPLY  AND  DEMAND 

economists  picked  no  quarrel  with  this  formula;  it 
ser\'^ed  well  enough  for  workaday  purposes  to  indicate 
the  lines  of  policy  which  they  rightly  thought  essential 
in  their  day. 

The  history  of  this  cry  is  the  history  of  every  cry 
which  has  won  a  wide  acceptance  from  mankind.  It  did 
good  work  for  perhaps  half  a  century;  but  then  many 
crimes  were  committed  in  its  name.  The  instrument 
which  had  been  forged  to  clear  away  a  noxious  tariff 
jungle  and  the  monstrous  laws  of  Settlement,  was 
turned  against  Lord  Shaftesbury  and  the  Factory  Acts. 
Not  only  was  inaction  recommended  to  Governments 
as  the  highest  wisdom;  other  institutions,  like  trade 
unions,  were  warned  off  the  economic  grass.  An  ideal 
of  perfect  competition  became  an  idol  to  which  much 
human  flesh  and  blood  were  sacrified. 

But,  what  is  more  to  our  present  purpose,  the  idea 
took  root  of  an  intimate  association  between  the  laws 
of  economics  and  the  policy  of  laissez-faire.  People 
who  opposed  some  long-overdue  measure  of  State 
regulation  believed  themselves  to  be  justified  by  the 
eternal  verities  of  economic  law,  and  this  claim  even 
the  advocates  of  the  measure  seldom  ventured  to 
dispute.  They  took  refuge  rather  in  a  conception  of 
economic  law  as  a  dangerous  monster,  whose  claws 
must  be  clipped  in  the  interests  of  the  higher  good. 
This  notion  that  all  interference  with  so-called  "free 
competition,"  is  a  violation  (though  very  likely  fully 
justified)  of  economic  laws  has  sunk  deep  into  our 
common  thought.  So  that  to  this  day,  whenever  we 
see  at  work  the  hand  of  a  State  department,  a  trust  or 
a  trade  union,  we  are  apt  to  say  "Demand  and  supply 


LABOR  141 

are  here  in  abeyance,"  and  possibly  we  add  "A  good 
thing  too."  Since  in  the  matter  of  wages,  the  hand  of 
the  trade  union  is  veiy  generally  evident,  it  is  impossible 
to  discuss  the  subject-matter  of  this  chapter,  until  we 
have  rid  our  minds  of  this  quite  baseless  prepossession. 
To  sweep  away  this  cobweb,  I  urge  the  reader  to 
recall  here  the  general  tenor  of  the  analysis  of  the 
preceding  chapters.  Whether  we  were  dealing  with  the 
price  of  an  ordinary  commodity,  with  joint  products, 
land  or  capital,  we  came  across  relationships  which 
seemed  altogether  more  fundamental  than  our  present 
industrial  system;  nor,  we  may  incidentally  observe, 
were  we  ever  required  to  suppose  that  the  present 
system  was  one  of  ''perfect  competition."  These 
relationships  were  almost  invariably  such  that  even  a 
world  socialist  commonwealth  would  find  it  necessary 
to  maintain  them.  It  was  not  suggested,  and  most 
certainly  it  must  not  be  thought,  that  a  world  socialist 
commonwealth,  or  even  a  more  modest  remodeling  of 
the  social  order  would  not  effect  great  changes,  possibly 
for  good,  and  possibly  for  ill.  The  same  economic  laws 
might  be  made  to  bear  very  different  fruits,  but  they 
themselves  would  remain  unchanged.  What  is  true  in 
all  these  other  fields — this  should  be  our  predisposi- 
tion— is  not  likely  to  be  quite  untrue  in  the  field  of 
labor. 

§  2.  Ideas  and  Institutions.  Another  point  is  worth 
noting  here.  We  are  sometimes  advised  to  distinguish 
sharply  between  "What  should  be"  and  "What  is"; 
often  two  very  different  things.  The  advice  is  perti- 
nent and  useful,  particularly  in  the  sphere  of  sociology. 


142  SUPPLY  AND  DEMAND 

But  our  incorrigible  habit  of  confusing  the  two  things 
together  is  not  without  justification,  or  at  least  excuse. 
For,  in  fact,  they  gravitate  towards  one  another  with  a 
force  which  is  just  as  strong  as  the  capacity  of  man  for 
understanding  and  controlling  his  environment.  When 
we  have  a  system  which  is  clearly  bad,  and  when  we  see 
our  way  to  make  it  better,  we  generally  make  the  change 
however  tardily.  Our  sense  of  "What  should  be"  thus 
reacts  upon  ''  What  is."  Meanwhile,  until  we  can  make 
the  system  better,  our  appreciation  of  "What  is" 
affects  our  sense  of  "What  should  be."  And  the  more 
so,  as  we  are  sensible.  For  "What  should  be"  is 
pre-eminently  an  affair  of  relativity.  A  man  may 
hold  very  strongly  that  equal  pay  to  every  individual 
is  desirable,  as  he  puts  it,  as  an  ideal.  But  this  will  not 
prevent  him,  in  a  world  in  which  managers  are  paid  far 
more  than  manual  workers,  from  maintaining  hotly 
(at  any  rate,  if  he  is  sensible)  that  to  pay  the  manager  of 
a  particular  concern  a  manual  worker's  wage  would 
be  monstrously  unfair.  He  would  also  argue  that  it 
would  be  highly  inexpedient.  Equity  and  expediency 
are,  in  fact,  intricately  intertwined  in  our  sense  of 
"What  should  be";  and  our  sense  of  "What  should 
be"  in  the  particular  is  governed  by  our  knowledge  of 
"  What  is"  in  the  general. 

These  may  seem  unnecessary  commonplaces.  But 
thej''  have  a  vital  bearing  on  the  modus  operandi  of  eco- 
nomic laws.  These  laws  do  not  work  in  vacuo.  They 
work  through  the  medium  of  the  acts  of  men.  The  acts 
of  men  are  greatly  influenced  by  their  institutions,  and 
by  their  ideas  of  right  and  wrong.  Both  institutions  and 
ideas  may  serve  to  smooth  rather  than  obstruct  the 


LABOR  143 

path  of  economic  laws;  because  the  laws  may  represent 
either  "what  should  be"  in  the  general,  or  "what  is"  in 
the  general,  and  therefore  "what  should  be"  in  the 
particulai*.  This  may  hold  true  even  of  a  trade  union 
or  a  sense  of  "fair  wages."  The  business  of  economic 
theory  is  not  to  justify  a  regime  of  laissez-faire,  still  less 
to  show  the  folly  of  bringing  morals  into  business.  Its 
value  is  rather  that  it  may  help  us,  by  improving  our 
understanding,  to  shape  our  institutions,  and  to  adopt 
our  moral  sentiments  so  as  to  promote  the  public  wel- 
fare. With  these  general  notions  in  our  minds,  let  us 
turn  to  see  how  stands  the  case  with  Labor. 

§  3.  The  General  Wage  Level.  The  term  Labor  may  be 
used  in  a  broad  or  in  a  narrow  sense.  It  may  be  confined 
to  weekly  wage-earners:  it  may  be  extended  to  include 
all  those  who  work,  as  the  phrase  goes,  "with  either 
hand  or  brain."  It  is  with  all  classes  of  Labor,  in  the 
broadest  sense  of  the  term,  that  we  must  here  concern 
ourselves.  It  will  be  convenient,  however,  in  the  first 
instance  to  ignore  the  differences  between  them,  and  to 
consider  the  forces  which  determine  what  we  may 
regard  as  the  general  wage-level. 

The  general  laws  of  supply  and  demand  hold  good. 
The  wages  of  labor  tend  to  a  level  at  which  the  demand 
is  equal  to  the  supply.  For,  if  the  demand  exceeds  the 
supply,  if,  in  other  words,  labor  is  scarce,  wages  tend  to 
rise,  sooner  or  later  in  any  case,  and  the  more  promptly 
in  proportion  as  the  workpeople  are  organized.  Con- 
versely, if  the  supply  exceeds  the  demand,  if  in  other 
words  there  is  general  unemployment,  wages  tend  to  fall, 
and  the  strongest  trade  unions  cannot  resist  the  ten- 


144  SUPPLY  AND  DEMAND 

dency,  though  they  may  delay  it.  Moreover,  the  higher 
the  wages  that  must  be  paid,  the  smaller,  other  things 
being  equal,  is  the  demand  for  labor.  For,  even  if 
we  leave  foreign  competition  out  of  account,  and  con- 
sider, as  it  were,  labor  throughout  the  world  as  a  whole, 
the  demand  for  labor  is  by  no  means  inelastic.  It  is 
derived  along  with  the  demand  for  the  other  agents  of 
production  in  the  manner  described  in  Chapter  V. 
As  was  there  shown,  the  greater  the  supply  of  the  other 
agents  of  production,  the  greater  is  likely  to  be  the 
demand  for  labor;  but  these  other  agents  can  be  sub- 
stituted for  labor  in  a  great  variety  of  ways,  and  an 
increase  in  wages  (unless  accompanied  by  increased 
efficiency)  will  make  it  profitable  for  employers  to  effect 
such  a  substitution,  where  it  was  not  profitable  before. 
Thus,  higher  wages  for  the  same  labor  efl5ciency  must 
stimulate  the  tendency  for  capital  to  act  as  a  substitute 
for  labor  at  the  expense  necessarily  (since  the  aggregate 
supply  of  capital  will  not  be  increased  thereby)  of  its 
tendency  to  serve  as  a  complement;  and  this  must  mean 
a  decrease  in  the  volmne  of  employment.  Hence  the 
power  of  labor  to  secure  a  general  advance  of  wages 
by  concerted  or  simultaneous  trade  union  action,  ap- 
plied if  you  will,  not  merely  to  every  industiy,  but  to 
every  country,  is  necessarily  very  limited.  Beyond 
a  certain  point,  such  a  policy  must  result  in  general 
unemployment;  and,  if  pushed  sufficiently  far,  in  un- 
emplojmient  so  extensive  that  it  would  continue  even 
in  periods  of  active  trade.  Such  a  policy  could  neither 
be  maintained  in  practice  nor  would  it  be  a  wise  policy 
from  the  workers'  point  of  view. 

In  other  words,  given  on  the  one  hand  the  conditions 


LABOR  145 

of  the  demand  for  labor  (i.  e.  the  supply  of  capital, 
natural  resources,  business  ability,  risk-bearing  and 
knowledge  of  technical  processes,  etc.,  which  happens 
to  exist),  and  given  on  the  other  hand  the  supply  of 
labor  (i.  e.  both  the  numbers  of  workpeople  and  their 
efficiency),  the  wage-level  in  the  long  run  is  fairly  rigidly 
determined.  The  introduction  of  the  phrase  "in  the 
long  run"  in  this  connection  is  apt  to  provoke  com- 
ment which  may  be  pertinent,  but  may  be  miscon- 
ceived. The  worker,  it  is  pointed  out,  is  deeply  con- 
cerned with  "the  short  run"  in  which  he  has  to  live.  It 
is  veiy  true;  and  it  is  this  that  supplies  one  of  the  many 
justifications  of  trade  unionism.  To  secure  for  the 
workers  advances  of  wages,  which  economic  conditions 
justify,  sooner  than  would  otherwise  have  been  obtained, 
is  certainly  no  trivial  or  contemptible  function.  But 
it  is  none  the  less  an  illusion  to  suppose  that  the  general 
wage-level  can  be  appreciably  and  permanently  raised 
by  trade  union  action,  except  in  so  far  as  it  increases 
the  efficiency  of  the  workers  or  incidentally  stimulates 
the  efiiciency  of  the  employers. 

§  4.  The  Supply  of  Labor  in  General.  The  efficiency 
of  labor  may  be  regarded  as  affecting  either  the  demand 
for  labor  on  the  one  hand  or  the  supply  of  it  on  the 
other,  according  as  we  look  at  the  matter  from  the 
worker's  or  the  employer's  standpoint.  The  employer 
is  concerned  with  the  labor  costs  per  unit  of  his  output, 
the  worker  is  concerned  with  the  wages  he  receives. 
An  increase  in  the  efficiency  of  labor  may,  and  usually 
will,  mean  both  a  decrease  in  labor  costs  to  the  employer 
and  an  increase  in  the  earnings  of  the  worker.     It  is 


146  SUPPLY  AND  DEMAND 

thus  wholly  to  the  good.  But  the  effects  of  an  increase 
in  the  supply  of  labor  in  the  sense  of  a  growth  in  the 
numbers  of  the  population  are  far  more  dubious.  Un- 
accompanied by  an  increase  in  the  demand  for  labor, 
it  must  result  in  a  diminished  remuneration  for  the  in- 
dividual worker.  To  some  extent  indeed  the  demand 
for  labor  would  almost  certainly  be  increased.  The 
supply  of  Capital  may  expand,  perhaps  proportion- 
ately, perhaps  more  than  proportionately  to  the  in- 
crease in  population.  But  one  factor  of  production,  as 
we  have  seen,  is  not  capable  of  such  expansion.  This 
is  the  factor  of  Land,  or  Natural  Resources.  It  is  the 
limitation  of  this  factor  which  gives  rise  to  what  we 
have  most  of  us  heard  of  as  The  Law  of  Diminishing 
Returns.  It  is  this  that  is  the  essence  of  the  problem 
of  Population,  portrayed  in  somber  hues  more  than  a 
hundred  years  ago  by  Malthus. 

This  problem  will  form  the  subject  of  the  sixth  vol- 
ume of  the  present  series.  In  the  meantime  it  may  be 
suggested  that  we  are  easily  credulous  if  we  suppose 
that  the  problem  has  been  finally  disposed  of  by  the 
peculiar  progress  of  an  abnormal  century.  But  that 
experience  has  at  least  destroyed  the  view  that  there 
need  he,  or  even  is  in  fact  in  Western  countries,  a  rela- 
tion between  real  wages  and  the  numbers  of  the  people  so 
close  and  direct  that  an  improved  standard  of  living 
must  be  temporary  only,  doomed  to  destroy  itself  by  the 
increased  population  it  engenders.  One  may  perhaps 
go  further  and  say  that  it  is  doubtful  even  in  what  di- 
rection changes  in  remuneration  will  influence  the 
aggregate  supply  of  labor.  When  we  pass  to  "what 
should  be,"  it  is  plain  that  there  is  nothing  whatever 


LABOR  147 

to  be  said  for  the  sort  of  relation  indicated  above.  The 
view  once  widely  held  that  the  principle  of  population 
must  inevitably  keep  the  mass  of  people  close  to  the 
verge  of  the  bare  means  of  subsistence  was  no  statement 
of  a  desirable  ideal.  It  was  a  nightmare;  a  nightmare 
none  the  less  though  it  may  haunt  us  yet.  It  is  far  from 
fanciful  to  suggest  that  it  is  because  this  relation  is  so 
obviously  not  "what  should  be"  that  it  may  be  ceasing 
to  hold  true  in  fact.  But  it  would  be  veiy  fanciful 
indeed  to  maintain  that  as  yet  ''what  should  be"  is 
represented  by  the  actual  population.  Thus,  just  as 
with  capital,  so  with  labor,  there  is  no  reason  to  sup- 
pose that  the  aggregate  supply  is  determined  by  any 
fundamental  economic  law,  or  corresponds  in  practice 
to  what  is  socially  desirable. 

§  5.  The  Apportionment  of  Labor  among  Places.  Again, 
as  with  capital,  it  is  when  we  turn  to  the  apportionment 
of  labor  between  different  employments  that  both 
economic  law  and  social  ideal  make  their  appearance. 
It  will  be  well,  however,  to  consider  briefly  in  the  first 
instance  the  different  question  of  its  apportionment 
between  places.  This  was  hardly  necessary  in  the  case 
of  capital,  because  the  possibilities  of  foreign  invest- 
ment are  very  numerous  and  easy:  the  mobility  of 
capital  is  thus  sufficiently  strong  (once  again  it  is  only 
marginal  adjustment  that  is  necessary)  to  establish 
over  at  least  a  large  part  of  the  world  something  near  to 
a  uniform  rate  of  interest.  But  this  is  not  the  case  with 
labor.  People  do  indeed  move  from  place  to  place 
within  a  country,  and  from  one  country  to  another,  in 
response  to  economic  opportunities.     That  even  the 


148  SUPPLY  AND  DEMAND 

latter  movement  may  be  a  considerable  thing,  the 
present  population  of  the  United  States  is  a  striking 
testimony.  But  obviously  the  mobility  is  very  in- 
complete. Here,  then,  we  have  what  we  might  loosely 
call  an  economic  law  that  labor  tends  to  "flow"  (as 
it  is  sometimes  unhappily  phrased)  to  those  places 
where  it  can  command  the  highest  reward;  we  have  this 
tendency  in  evidence,  but  it  is  far  too  weak  to  enable  us 
to  lay  down  what  would  deserve  more  strictly  the  title 
of  an  economic  law,  that  in  the  long  run  the  reward  of 
the  same  kind  of  labor  is  roughly  equal  in  all  places. 
Perhaps  we  can  say  this  for  many  districts  in  a  single 
country;  but  for  few  countries  is  this  true  as  between 
all  their  districts.  As  between  countries,  it  is  not  re- 
motely true. 

Here,  however,  the  imperfection  of  economic  law  is 
balanced  by  an  extreme  uncertainty  as  to  the  ideal. 
Perfect  mobility  of  labor  may  be  economically  desirable 
in  a  very  narrow  sense  of  the  term;  but  it  opens  out  a 
vista  of  racial,  national  and  cultural  problems,  into 
which  it  will  be  better  for  us  not  to  enter  here.  We 
must  take  for  granted  the  population  of  a  country, 
like  that  of  the  world,  as  a  given  fact. 

When  we  do  this,  the  question  of  its  remuneration 
is  on  all  fours  with  the  more  general  question  discussed 
above.  That  the  remuneration  of  the  labor  of  a  coun- 
try is  mainly  governed  by  the  relations  between  demand 
and  supply  is  an  inexorable  fact.  In  view  of  the  interna- 
tional mobility  of  capital,  the  main  distinctive  factor  in 
the  demand  for  the  labor  of  a  particular  country  is  the 
supply  of  natural  resources,  which  it  knows  how  to  use. 
Where  the  natural  resources  are  great  relatively  to  the 


LABOR  149 

population,  there  wages  will  rule  high;  where  the  con- 
verse is  true,  wages  will  rule  low.  This  result  of  eco- 
nomic analysis  is  abundantly  confirmed  by  experience. 
The  relatively  high  wages  in  the  new  world,  the  low 
standard  of  hving  in  the  densely  populated  East;  the 
economic  history  of  Ireland  are  so  many  object-lessons 
of  its  truth. 

§  6.  The  Apportionment  of  Labor  among  Social  Grades. 
The  question  of  the  apportionment  of  the  labor  of  a 
country  amoug  different  employments  falls  under  two 
heads.  Some  differences  of  occupation  are  associated 
particularly  in  Great  Britain  with  differences  of  what 
we  know  as  class.  The  movement  of  labor  between 
different  social  grades  is  clearly  a  very  different  thing 
from  its  movement  between  different  occupations  in  the 
same  grade.  The  grades  themselves  are  not  easy  to 
define:  not  a  little  ingenuity  has  been  expended  on  the 
attempt,  and  perhaps  the  best  brief  classification  that 
has  been  put  forward  is  one  which  divides  labor  into  the 
following  four  grades: — 

(1)  Automatic  manual  labor. 

(2)  Responsible  manual  labor. 

(3)  Automatic  brain  workers. 

(4)  Responsible  brain  workers. 

But  the  matter  is  one  perhaps  for  the  satirist  of  manners 
rather  than  the  economist.  It  suffices  for  our  purpose 
that  the  distinctions,  however  vague,  are  very  real. 

It  is  obvious  the  mobility  of  labor  between  the  oc- 
cupations of  a  platelayer  and  a  barrister  is  not  very 
great.    It  may  seem  perhaps  to  be  even  smaller  than  it 


150  SUPPLY  AND  DEMAND 

is.  For  here  it  is  important  to  bear  in  mind  a  general 
consideration  which  is  equally  applicable  to  horizontal 
movements  within  any  social  grade.  There  may  be  a 
considerable  movement  of  labor  between  different  em- 
ployments without  any  individual  worker  having  to 
change  his  occupation.  The  personnel  of  any  industry 
is  constantly  changing.  At  one  end,  men  die,  retire,  or 
are  pensioned  off;  at  the  other  end,  young  recruits  are 
taken  on.  By  a  diversion  of  the  new  recruits  from  one 
employment  to  another,  a  radical  change  can  be  made 
in  the  occupational  census  in  a  comparatively  short 
space  of  time.  It  is  in  this  m.anner  that  such  move- 
ment as  takes  place  is  largely  effected  at  the  present 
time.  Within  the  ranks  of  the  professional  classes,  a 
man  does  not  commonly  leave  the  profession  to  which 
he  has  been  trained.  But  his  choice  of  profession  is  de- 
termined by  him  or  his  parents  not  solely  on  pecuniary 
grounds  but  usually  with  an  anxious  scanning  of  the 
general  prospects,  which  include  pecuniary  advantages 
together  with  many  other  things.  The  same  thing  is 
true  in  no  small  measure  of  manual  wage-earners.  This 
general  consideration  must  be  borne  in  mind  through- 
out the  remainder  of  this  chapter. 

But  even  the  sons  of  platelayers  do  not  commonly 
practise  at  the  bar.  The  obstacles  in  the  way  are  vari- 
ous and  subtle.  Many  of  them  are  ideas,  inherited 
from  a  bygone  epoch,  about  keeping  other  people  "in 
their  proper  stations,"  which  the  whole  drift  of  circum- 
stance, and  the  spirit  of  the  age  are  rapidly  wearing 
down.  In  the  new  world  such  obstacles  are  rare.  But 
an  obstacle  of  a  more  tangible  and  formidable  kind 
arises  from  the  fact  that  the  liberal  professions  and 


LABOR  151 

many  business  careers  require  a  long  and  expensive 
education  and  training,  which  the  platelayer  is  quite 
unable  to  afford  to  give  his  son. 

Now  this  expense  of  training  is  highly  relevant  not 
only  to  "what  is,"  but  to  "what  should  be."  It  in- 
cludes, it  should  be  observed,  a  negative  as  well  as  a 
positive  element;  a  long  period  of  waiting  before  income 
begins,  as  well  as  the  actual  outlay  on  educational  and 
other  charges.  When  the  burden  both  of  the  waiting 
and  the  positive  costs  must  be  borne  either  by  the  in- 
dividual or  the  family,  there  are  few  people  who  would 
seriously  dispute  that  this  goes  to  justify,  on  grounds 
of  fairness  as  well  as  of  expediency,  a  higher  level  of  an- 
nual remuneration  later  on;  though  many  people  would 
doubtless  argue  that  the  amenities  and  dignities  of  the 
professions  should  be  taken  into  account  on  the  other 
side.  But  the  same  consideration  makes  it  a  matter  of 
legitimate  doubt  whether  it  would  be  desirable,  even  as 
an  ideal,  that  the  community  should  provide  so  com- 
pletely the  costs  of  training  and  of  maintenance  in  the 
waiting  period,  as  to  make  it  no  longer  "fair"  that  the 
individual  should  be  remunerated  more  highly  than 
workers  in  less  expensive  occupations.  For  this  would 
mean  that  more  labor  would  be  absorbed  in  the  former 
employments  than  in  principle  would  be  socially  desir- 
able, for  reasons  which  the  argument  of  the  next  chap- 
ter will  make  plain.  But  the  most  desirable  number  of 
doctors,  barristers,  teachers,  etc.,  is  not  a  thing  which 
can  be  settled  on  purely  economic  grounds,  and  it  is 
unprofitable  to  carry  further  this  particular  line  of 
thought.  Few  people  would  advocate,  as  an  ultimate 
'deal,  that  the  remuneration  of  the  professional  grades 


152  SUPPLY  AND  DEMAND 

of  labor  should  exceed  that  of  lower  grades  by  more  than 
the  extra  expense  of  training  and  waiting  they  involve. 
That  the  excess  is  usually  greater  than  this  at  the 
present  time  seems  very  probable:  though  it  is  a  matter 
on  which  it  is  very  hard  to  generalize.  But  it  would 
certainly  be  far  greater  than  it  is  if  the  principle  of 
laissez-faire  ruled  supreme  in  these  affairs.  Fortu- 
nately it  does  not,  and  has  never  done  so.  Even  before 
the  days  of  free  elementary  education,  the  endowment 
of  education  was  not  unknown.  The  ancient  public 
schools  and  universities,  which  have  come  down  to  us 
from  the  Middle  Ages,  are  a  standing  witness  to  what 
in  this  field  a  far  poorer  community  thought  fit  to  do. 
Their  systems  of  scholarships  and  exhibitions,  no  less 
than  their  courts  and  towers,  deserve  our  notice.  For 
these  were  designed  to  form  what  we  now  call  "a  lad- 
der" by  which  talent  could  climb  from  the  humblest 
origins  to  the  callings  which  then  seemed  the  summit 
either  of  spiritual  or  of  worldly  ambition. 

This  reference  to  ''talent"  makes  it  well  to  consider 
here  a  factor  which  necessarily  complicates,  though  it 
does  not  substantially  affect,  the  whole  argument  of 
the  present  chapter.  There  are  differences  of  natural 
ability,  which  no  education  or  training  can  obliterate, 
which  it  should  rather  be  their  business  to  excite. 
These  differences  are  associated  to  a  great  extent  with 
differences  of  occupation;  they  should  he  so  associated 
far  more  closely  than  in  fact  they  are.  They  are  also 
associated  with  differences  of  remuneration  even  within 
the  same  occupation;  "what  should  be"  here  is  a  ques- 
tion which  we  may  excuse  ourselves  from  discussing. 
The  principle  which,  however  vague,  is  sufficient  for 


LABOR  153 

our  present  purpose  is  that  the  same  natural  ability 
should  command  the  same  reward  in  all  occupations, 
subject  to  differences  which  should  not  exceed  the  dif- 
ferences of  educational  cost  and  initial  waiting  they 
involve.  We  cannot  assert,  as  an  economic  law,  that 
this  is  generally  true  in  fact.  If  ever  it  becomes  true, 
it  will  be  due  not  to  "laissez-faire,"  or  "free  competi- 
tion," but  to  social  arrangements,  which  express  a 
sense  of  what  is  right. 

§  7.  The  Apportionment  of  Labor  among  Occupations. 
When  we  pass  to  the  apportionment  of  labor  among 
different  occupations  in  the  same  social  grade,  the  same 
principle  as  to  "what  should  be"  applies  in  a  simpler 
form.  Equal  natural  ability  should  command  an  equal 
reward  in  all  occupations;  assuming  that  differences 
in  cost  of  training  can  be  ignored.  The  reward  must, 
of  course,  be  interpreted  not  in  terms  of  money  only 
but  of  "real  wages,"  with  allowance  for  the  varying 
amenities  of  different  tasks.  Now  it  was  here  that  the 
extreme  advocates  of  laissez-faire  made  one  of  their 
cardinal  mistakes.  They  assumed  that  this  ideal  would 
be  best  secured  by  "perfect  competition."  The  em- 
ployer would  choose  the  worker  who  would  come  for 
the  lowest  wage;  the  worker  would  choose  the  employer 
who  would  pay  him  the  highest  v/age;  and  so,  by  a  proc- 
ess similar  to  the  higgling  of  a  commodity  market,  the 
desirable  uniform  wage-level  would  become  established. 
But  in  fact  the  conditions  of  the  labor  market  differ 
greatly  from  those  of  a  commodity  market.  People 
are  ignorant,  do  not  look  ahead,  cannot  afford  to  risk 
the  loss  of  a  job,  however  wretched,  which  they  happen 


154  SUPPLY  AND  DEMAND 

to  have  got.  For  reasons  such  as  these,  a  considerable 
departure  from  laissez-faire  is  necessary  in  order  to 
realize  the  theoretical  results  of  laissez-faire.  To  pre- 
vent the  putting  of  boys  in  large  numbers  into  "blind 
alley"  occupations,  you  must  supplement  the  foresight 
of  parents  with  Juvenile  Employment  Exchanges  and 
After-Care  Committees.  To  secure  a  proper  uniformity 
of  wages  within  the  same  occupation,  you  must  have 
trade  unions.  To  secure  a  proper  uniformity  between 
different  occupations,  you  must  have  again  trade  unions, 
or,  failing  them,  Trade  Boards. 

That  the  actions  of  trade  unions  are  very  largely  of 
this  type  is  a  fact  insufficiently  appreciated  by  the 
middle-class  public.  The  elaborate  system  of  piece-rate 
lists  which  has  been  evolved  in  the  Lancashire  cotton 
industry  is  primarily  designed  to  secure  the  same  wage 
for  workers  of  equal  efficiency  in  all  mills,  irrespective 
of  the  degree  to  which  the  machinery  is  antiquated  or 
up  to  date.  This  result  is  wholly  to  the  good :  not  only 
does  it  secure  "fairness"  for  the  worker,  it  stimulates 
the  employer  wonderfully  to  efficiency.  The  same  re- 
sult could  never  be  secured  so  effectively  by  the  free 
play  of  competition.  But  this  tendency,  which  is  easily 
the  predominant  element  in  the  trade  union  regula- 
tions of  the  cotton  trade,  is  at  least  an  important  ele- 
ment in  the  policy  of  "The  Common  Rule"  of  all  trade 
unions,  though  it  may  often  be  mixed  up  with  the  more 
questionable  tendency  to  eliminate  differences  of  pay 
for  differences  of  natural  ability,  and  the  unquestionably 
bad  tendency  to  discourage  output.  As  between  dif- 
ferent occupations,  the  insistence  of  a  trade  union  that 
wages  must  be  leveled  up  towards  the  wages  obtaining 


LABOR  155 

in  similar  trades  acts  again  as  a  far  moi-e  powerful  force 
than  competition. 

But  the  actions  of  trade  unions  are  by  no  means 
wholly  of  this  type.  They  often  serve  rather  to  secure 
still  higher  wages  for  workers  who,  comparatively 
speaking,  are  already  highly  paid.  It  makes  little 
difference  whether  this  effect  is  secured  directly  by 
wage  demands,  or  indirectly  by  restricting  the  right 
of  the  entry  to  the  trade.  In  either  case  the  conse- 
quences are  the  same,  and  there  should  be  no  ambiguity 
as  to  their  nature.  They  are  certainly  bad  for  the  com- 
munity, certainly  bad  for  the  other  workers  of  the 
grade,  almost  certainly  bad  for  the  workers  of  the 
grade  regarded  as  a  whole.  The  higher  wages  must 
raise  the  money  costs  of  production,  and  result,  sooner 
or  later,  in  fewer  workpeople  being  employed  in  that 
occupation;  larger  numbers  must  accordingly  seek 
employment  elsewhere;  and  this  cannot  but  depress 
the  wage  rates  of  less  strongly  organized  trades.  Thus 
the  effect  is  twofold :  a  larger  proportion  of  workpeople 
will  be  employed  in  badly  paid  occupations;  and  the 
wages  there  will  be  lessened. 

The  power  of  a  strong  trade  union  to  secure  wage 
advances  of  this  type  is  considerable,  but  it  must  not 
be  exaggerated.  Trade  unions  employ  as  a  matter 
of  course  devices  which,  in  the  case  of  trusts,  we  regard 
as  the  extremest  weapons  of  monopoly.  To  say,  "If 
you  buy  from  anyone  except  us,  you  must  not  buy  at 
a  lower  price  than  ours,"  which  Messrs.  J.  &  P.  Coats 
are  represented  as  having  done,  is  analogous  to  insisting 
that  if  non-unionists  are  employed,  it  shall  be  at  the 
trade  union  rate,  as  every  trade  union  very  properly 


156  SUPPLY  AND  DEMAND 

insists.  To  say,  "You  must  buy  only  from  us,"  the 
method  of  the  boycott,  as  it  is  called,  is  analogous  to 
the  very  common  refusal  to  work  with  non-unionists 
at  all.  But  in  one  important  respect  the  tactical  posi- 
tion of  a  trade  union  is  weaker  than  that  of  an  ordinary 
combination.  It  has  usually  got  a  buyers'  combination 
up  against  it,  in  the  shape  of  an  association  of  employers. 
The  latter  will  be  governed  in  their  attitude  towards 
the  workpeople's  demands,  not  only  by  unmediate 
expediency,  but  also  by  their  own  sense  of  "what  should 
be";  and  they  will  usually  resist  demands  for  wages 
greatly  in  excess  of  those  obtaining  in  comparable 
trades.  In  this  way,  the  tendency  for  workers  of  the 
same  efficiency  to  receive  the  same  real  wages  in  all 
employments  is  far  stronger  than  might  at  first  sight 
appear. 

If  we  had  to  rely  for  this  result  upon  trade  unions 
alone,  it  would  be  highly  problematical.  For  here  a 
psychological  curiosity  emerges,  which,  familiar  and 
intelligible  as  it  is,  is  none  the  less  a  curiosity.  So 
far  from  still  higher  wages  for  well-paid  workpeople 
being  regarded  in  the  world  of  manual  labor  as  detri- 
mental to  the  interests  of  other  workpeople,  it  has  be- 
come almost  a  point  of  honor  to  believe  the  contrary. 
A  wage  dispute  in  a  particular  trade  is  conceived  as 
an  engagement  in  a  far-flung  battle  between  Capital 
and  Labor,  in  which  success  at  any  part  of  the  line 
will  facilitate  the  victory  of  the  whole  army.  This 
conception  contains  a  measure  of  truth,  as  regards 
immediate  and  purely  temporary  effects;  though, 
even  here,  it  is  made  to  seem  unduly  plausible  by  the 
recurrence  of  trade  cycles,  which  cause  wages  at  any 


LABOR  157 

time  to  move  in  the  same  direction  all  along  the  line. 
But,  if  the  foregoing  analysis  has  been  appreciated, 
the  essential  falsity  of  this  notion  should  be  evident. 
It  is  an  illusion,  which  should  receive  no  endorsement, 
either  tacit  or  express,  in  any  work  on  economics. 
The  general  wage  level  of  a  countiy  cannot  be  regarded 
(except  temporarily,  and  within  narrow  limits)  as  a 
function  of  the  efficiency  of  labor  organization;  it 
depends  on  the  far  deeper  economic  facts  set  out  in 
§  3  above. 

Let  us  now  try  to  summarize  the  conclusions  of  this 
section.  There  is  a  tendency  towards  a  uniformity 
of  real  wages  for  workers  of  the  same  grade  and  of  the 
same  efficiency.  This  tendency  is  not  due  to  competi- 
tion alone.  It  is  helped  by  many  acts  of  a  collective 
kind,  arising  from  a  sense  of  ''what  should  be":  it  is 
obstructed  by  other  acts  of  a  like  kind,  v/here  the  sense 
of  "what  should  be"  is  based  on  imperfect  under- 
standing. The  more  people  act  in  accordance  with 
"what  should  be,"  and  the  better  their  understanding, 
the  more  will  this  tendency  approximate  to  an  accurate 
economic  law. 

§  8.  Women's  Wages.  The  wages  of  women  represent 
a  problem  of  great  public  interest,  upon  which  the 
principles  laid  down  in  this  chapter  have  a  most  impor- 
tant bearing,  and  which  in  its  turn  serves  to  illustrate 
these  principles  further.  It  has  been  suggested  that 
male  and  female  labor  can  be  regarded  as  a  strong  case 
of  Joint  Supply,  and  the  suggestion  is  not  merely  face- 
tious. The  essential  point,  that  the  proportions  of 
available  male  and  female  labor  are  fairly  constant  (not 


158  SUPPLY  AND  DEMAND 

that  they  may  not  alter  with  time  and  circumstances, 
but  that  they  are  essentially  independent  of  the  condi- 
tions of  demand)  holds  true  not  only  of  a  country  as  a 
whole,  but  hardly  less  of  a  particular  district.  If  men 
and  women  are  to  be  regarded  as  separate  grades,  they 
are  grades  between  which  immobility  is  complete. 
Now  men  and  women  differ  in  many  ways  which  affect 
both  the  demand  for  and  the  supply  of  their  services. 
On  the  one  hand,  far  fewer  women  wish  to  enter  busi- 
ness employments  of  any  kind,  as  women  have  plenty  of 
work  that  must  be  done  at  home.  On  the  other  hand, 
though  women  can  do  many  kinds  of  work  as  v/ell  as 
or  better  than  men,  it  so  happens  that  for  much  the 
greater  number  of  services,  which  are  in  large  demand 
in  the  business  world,  men  are  the  more  efficient. 
Incidentally,  it  happens  that  many  occupations  which 
women  might  do  as  well  as  men  are  closed  to  them  by 
exclusive  regulations.  The  resultant  of  these  forces 
is  that  men  and  women  are  for  the  most  part  employed 
in  difTerent  occupations,  and  the  scale  of  payment 
in  women's  occupations  is  far  lower  than  that  in  men's. 
Of  this  last  fact  singularly  small  complaint  is  made. 

It  is  otherwise,  however,  when  we  come  to  occupa- 
tions where  men  are  either  wholly  or  partially  empIoj''ed, 
where  women  are  at  least  approximately  as  efficient 
as  men,  and  where  the  barriers  to  their  entry  are  at 
least  fonnally  removed.  There  a  ferocious  controversy 
rages  over  what  is  known  as  the  principle  of  "equal 
pay  for  equal  work."  It  is  easy  to  understand  why 
the  male  trade  unionists  in,  let  us  say,  the  engineering 
trades,  should  support  this  claim.  It  is  also,  indeed, 
intelligible  why  the  enthusiasts  for  Women's  Rights 


LABOR  159 

should  urge  it;  but  it  is  much  more  doubtful  whether 
they  are  wise.  Possibly  they  are  wise  enough  in  their 
generation,  since  it  might  not  serve  them  on  this  matter 
to  get  across  the  men.  But  it  is  clearly  not  prudential 
considerations  of  this  kind  by  which  they  are  mainly 
actuated.  They  make  the  demand,  with  extreme 
intensity  of  feeling,  as  a  demand  for  fimdamental 
justice.  They  are  also  veiy  obviously  inspired  with  the 
bellfef  (similar  to  the  illusion  which  is  a  point  of  honor 
with  the  male  trade  unionist)  that  high  wages  for 
women  in  well-paid  occupations  will  help  to  raise  the 
wages  of  sweated  women  workers  in  other  trades. 

Now,  here  again,  any  lack  of  candor  would  be  in- 
excusable. The  effect  of  this  policy  on  the  wages  in 
women's  trades  is  certainly  to  reduce  them.  The  pol- 
icy serves,  as  powerfully  as  any  trade  union,  custom, 
to  restrict  the  entry  of  women  into  the  men's  employ- 
ments, and  often  spells  virtual  exclusion.  For  the 
"equal  efficiency"  may  be  approximate  only,  and  there 
may  be  advantages  in  male  labor  from  the  employer's 
standpoint  which  are  none  the  less  important,  because 
they  are  not  easy  to  define.  Moreover,  from  the  em- 
ployer's standpoint,  the  efficacy  of  female  labor  will 
be  largely  a  matter  for  experiment,  and  "equal  pay" 
will  give  him  no  inducement  to  experiment  at  all. 
The  diminished  number  of  women  in  these  occupations 
(as  compared  with  what  might  have  been)  increases 
the  number  who  must  fall  back  on  the  purely  women's 
trades;  and  it  must  serve  to  reduce  the  wages  there, 
where  organization  is  by  no  means  strong.  I  am  far 
from  asserting  that  this  consideration  is  conclusive 
against  the  principle  of  "equal  pay  for  equal  work" 


160  SUPPLY  AND  DEMAND 

(though  I  think  it  conclusive  against  a  rigid  interpreta- 
tion of  it) ;  for  other  matters,  such  as  the  standpoint  of 
the  male  trade  unionist  must  be  taken  into  account. 
But  the  reactions  on  the  wages  in  women's  trades  per- 
mit of  no  ambiguity. 

In  occupations  of  another  type,  the  issue  takes  a 
somewhat  differeat  form.  In  the  teaching  profession, 
''equal  pay"  would  not  exclude  the  women;  it  would 
be  far  more  likely  to  exclude  the  men.  For,  though  the 
advocates  of  the  principle  would  declare  that  their 
intention  is  that  the  salaries  of  women  should  be  leveled 
up  to  those  of  men,  it  is  more  probable  that  the  ultimate 
outcome  would  be  a  leveling  down.  Educational 
authorities  have  the  ratepayer  and  the  taxpayer  to 
consider;  and,  apart  from  this,  they  have  their  own 
interpretation  of  "what  should  be."  To  pay  a  woman 
less  than  a  man  for  the  same  work  may  seem  glaringly 
unfair;  but  it  is  not  very  clear  why  a  woman,  who  is 
an  elementary  school  teacher,  should  be  paid  much 
more  than,  say,  a  hospital  nurse,  merely  because  in  the 
former  case  a  number  of  men  happen  also  to  be  em- 
ployed. In  fact,  there  is  a  clashing  of  equities  in  this 
connection;  and  there  is  little  doubt  which  of  them 
the  educational  authorities  would  prefer.  A  leveling 
down  of  the  men's  salaries  would  make  it  all  but  im- 
possible to  attract  men  of  the  desired  type  into  the 
profession,  and  would  thus  lead  to  the  virtual  extinction 
of  the  male  elementary  school  teacher.  This  might 
seem  in  a  narrow  sense  to  be  economically  desirable. 
Why  should  not  men  take  their  services  to  the  tasks 
for  which  they  can  command  a  higher  reward,  and  which 
women  cannot  do  as  well?    But  whether  this  would 


LABOR  161 

be  desirable  in  the  true  interests  of  education  is  a  far 
more  doubtful  matter.  And  this  is  the  real  problem 
of  "equal  pay  for  equal  work"  for  male  and  female 
school  teachers.  The  reader  will  notice  that  I  have 
refrained  from  alluding  to  the  controversy  as  to  whether 
men  should  receive  more  on  the  grounds  that  they  have 
wives  and  families  to  maintain.  That,  although  a  most 
absorbing  issue,  is  not  the  real  issue  in  practice  at  the 
present  time.  The  real  issue  is  a  clashing  between  a 
sense  of  "what  should  be"  on  obvious  general  grounds 
and  a  sense  of  "what  should  be  "  in  the  particular,  de- 
rived from  the  very  patent  and  general  "what  is"  that 
men  receive  as  a  rule  far  higher  pay  than  women. 


CHAPTER  X 

THE  REAL  COSTS  OF  PRODUCTION 

§  1.  Comparative  Costs.  Beneath  the  great  diversity 
of  the  considerations  which  are  appHcable  to  the  dif- 
ferent agents  of  production,  certain  general  conclu- 
sions emerge  from  the  analysis  of  the  last  four  chapters. 
In  no  case  did  we  find  that  the  aggregate  supply  of  the 
agent  was  determined  by  clear  and  certain  economic 
laws,  possessing  any  fundamental  significance.  The 
supply  of  natural  resources  is  a  fixed  thing,  quite  in- 
dependent of  the  efforts  or  the  desires  of  man.  How- 
ever the  supply  of  capital  and  the  supply  of  labor 
may  react  under  present  conditions  towards  economic 
stimuli,  these  reactions  possess  no  quality  of  inevita- 
bility and  bear  no  clear  relation  to  "what  should  be." 
The  supply  of  risk-bearing  responds  perhaps  more 
decidedly  to  the  prospects  of  increased  reward;  but 
it  is  so  intimately  associated  Avith  special  loiowledge 
and  the  qualities  of  business  enterprise,  as  to  leave 
some  uncertainty  attaching  even  to  this  conclusion. 
When,  on  the  other  hand,  we  turn  to  the  apportion- 
ment of  these  factors  among  different  uses,  we  find 
relations  which  are  both  clear  and  fundamental.  Laws 
emerge  which  state  at  once  not  only  "what  is"  or  at 
least  "what  tends  to  be,"  but  also  "what  should  be"; 
and  it  is  the  fact  that  they  taste  "what  should  be" 
that  gives  them  their  fundamental  character. 

162 


THE  REAL  COSTS  OF  PRODUCTION     163 

These  conclusions  enable  us  to  give  a  general  answer 
to  the  question  which  was  raised  at  the  end  of  Chap- 
ter V:  What  are  the  ultimate  real  costs  to  which  the 
money  cost  of  production  correspond?  The  attempt 
has  often  been  made  to  relate  money  costs  to  such 
things  as  the  effort  of  working  and  the  sacrifice  of  wait- 
ing. The  existence  of  such  costs  is  beyond  dispute. 
Much  saving  does  mean  a  sacrifice  of  immediate  enjoy- 
ment to  the  man  who  saves.  Most  labor  is  irksome  and 
disagreeable  in  itself,  and  involves  strain  and  wear  and 
tear;  while  all  labor  means  a  deprivation  of  the  utility 
of  leisure.  Workpeople,  moreover,  do  not  grow  on 
gooseberry  bushes,  but  must  be  fed  and  clothed  from 
the  cradle;  and  their  rearing  and  maintenance  repre- 
sents a  real  cost  which  someone  must  incur. 

But  the  existence  (or  the  importance)  of  such  costs 
is  one  thing,  their  relation  to  money  costs  is  another. 
In  Chapter  VIII  we  saw  how  difficult  it  was  to  estabhsh 
any  clear  relation  between  the  rate  of  interest  and  the 
sacrifice  of  saving.  The  costs  of  labor  present  similar 
difficulties.  The  relative  irksomeness  of  two  occupa- 
tions may  affect  the  relative  wages  which  will  rule  in  the 
two  cases;  so,  certainly,  will  the  differences  in  the  cost 
of  education  and  training  which  they  require.  But 
these  are  matters  which  concern  the  apportionment 
of  labor  between  different  employments.  There  is 
no  good  reason  to  suppose  that  the  general  wage-level 
would  be  reduced,  merely  because  work  as  a  whole 
became  less  irksome,  or  involved  a  smaller  physical  or 
mental  strain.  The  supply  of  people  is  not  determined 
by  the  same  kind  of  influences  as  is  the  supply  of  a 
commodity.    Parents  do  not  produce  children  for  the 


164  SUPPLY  AND  DEMAND 

sake  of  the  wages  which  the  children  will  receive  when 
they  go  out  to  work;  or,  if  this  happens,  we  rightly 
regard  it  as  a  horrible  anomaly.  In  so  far  as  parents 
are  affected  by  economic  conditions  it  is  by  their  own 
economic  conditions;  the  question  is  rather  one  of 
how  many  children  they  can  afford  to  have,  than  of  a 
balancing  of  the  cost  to  them  against  the  incomes 
which  their  children  may  subsequently  acquire.  But 
other  considerations  enter  in;  and,  in  fact,  it  is  doubtful 
how  the  aggregate  supply  of  labor  will  react  to  changes 
in  prosperity.  Finally,  the  supply  of  land  involves 
neither  effort  nor  sacrifice;  and,  among  our  money 
costs,  we  have  to  accomit  for  the  item  of  the  rent  of  land. 
To  dispose  of  this  difficulty  by  arguing  that  rent  does 
not  enter  into  marginal  costs  (in  any  sense  which  is  not 
equally  true  of  wages  and  profits)  is  to  lose  contact 
with  reality.  Thus  the  attempt  to  explain  money 
costs  in  terms  of  the  costs  of  producing  the  ultimate 
agents  of  production  leads  us  into  a  quagmire  of  unreal- 
ity and  dubious  hypothesis.  For  a  systematic  theory, 
which  will  rest  on  firm  foundations,  we  must  interpret 
money  costs  in  very  different  terms. 

The  real  costs  which  the  price  of  a  commodity  meas- 
ures are  not  absolute,  but  comparative.  Marginal 
money  costs  reduce  themselves  in  the  last  analysis 
to  the  payments  which  must  be  made  to  secure  the  use 
of  the  requisite  agents  of  productions.  These  payments 
tend  to  equal  the  payments  which  the  same  agents 
could  have  commanded  in  alternative  employments. 
The  payments  which  they  could  have  commanded  in 
alternative  employments,  tend  in  their  turn  to  equal 
the  derived  marginal  utilities  of  their  services  in  those 


THE  REAL  COSTS  OF  PRODUCTION     165 

employments.  It  is  thus  the  loss  of  Utility  which 
arises  from  the  fact  that  these  agents  of  production 
are  not  available  for  alternative  employments  that  is 
measured  by  the  money  costs  of  a  commodity  at  the 
margin  of  production. 

This  conception  of  ultimate  costs  encounters  an 
instinctive  repugnance,  arising  from  a  mistaken  sense 
of  logical  symmetry,  which  it  will  be  well  to  examine. 
Cost,  it  is  objected,  so  interpreted  loses  its  character 
as  an  independent  entity.  It  is  merely  something  de- 
rived from  utility.  Now  in  the  earlier  chapters  of 
this  volume,  we  found  reason  to  be  impressed  with 
the  general  sjTnmetry  which  pervades  the  relations 
of  demand  and  supply.  Moreover,  when  we  considered 
the  case  of  ordinaiy  commodities  we  found  that  at 
the  back  of  demand  and  giving  rise  to  it  was  utilitj''; 
at  the  back  of  supply,  and  limiting  it,  was  cost.  The 
general  sjnimietry  between  demand  and  supply  thus 
seemed  ahnost  to  imply  a  fundamental  symmetry 
between  utility  and  cost.  If,  then,  cost  in  the  last 
analysis  is  derived  from  utility,  does  not  this  make 
nonsense  of  the  symmetry  between  demand  and  supply, 
or,  if  we  cling  to  this  last  symmetry  as  a  demonstrable 
truth,  must  we  not  refuse  to  admit  that  cost  can  be 
derived  from  utility? 

This  is  one  of  those  false  dilemmas  which  supply  the 
wiseacres  of  the  world  with  a  plausible  case  for  dis- 
trusting the  logical  faculty.  If  we  have  good  reason  for 
beheving  that  both  of  two  apparently  inconsistent 
things  are  true,  the  explanation  is  seldom  that  one  of 
them  is  really  false;  it  is  more  usually  that  they  are 
not  really  inconsistent.    So  it  is  here.    The  symmetry 


166  SUPPLY  AND  DEMAND 

between  demand  and  supply  is  very  great,  and  we 
should  always  look  to  see  if  it  holds  good,  but  it  is  by  no 
means  perfect,  and  it  is  in  the  last  analysis  that  it  most 
notably  fails.  It  is  most  important  to  distinguish 
clearly  between  the  utility  and  the  cost  of  a  com- 
modity as  two  separate  and  independent  things.  In 
Chapter  V,  it  will  be  remembered,  we  did  not  permit 
ourselves  to  derive  the  costs  of  producing  cotton  lint 
from  the  utility  of  cotton-seed.  The  refusal  to  do  so  was 
essential  to  clear  thought;  it  led  to  some  very  useful 
practical  corollaries.  But  to  derive  the  cost  of  a  com- 
modity from  the  utility  of  something  which  is  produced 
with  it,  as  part  of  the  same  productive  process;  and  to 
derive  the  cost  from  the  utilities  which  the  agents, 
which  help  to  produce  it,  possess  for  other  purposes,  are 
two  entirely  different  things.  In  works  on  International 
Trade,  the  reader  will  discover  that  the  comparative 
nature  of  real  costs  is  so  unmistakable  that  a  Doctrine 
of  Comparative  Costs  is  expounded  with  much  formal- 
ity at  the  outset.  This  doctrine  is  apt  to  prove  some- 
what puzzling,  when  we  have  to  deal  with  it  as  an  appar- 
ent exception  to  the  general  tenor  of  economic  theory. 
Its  difficulties  disappear  when  we  realize  clearly  that 
the  real  cost  of  anything  is  the  curtailment  of  the  supply 
of  other  useful  things,  which  the  production  of  that 
particular  thing  entails. 

§  2.  The  Allocation  of  Resources.  However  strange  the 
above  conception  may  seem,  there  should  be  no  doubt 
that  this  cost  is  very  "  real."  Here  the  irregularities  and 
maladjustments  of  the  economic  world,  the  recurrence 
of  trade  depressions  and  the  like,  do  much  to  obscure 


THE  REAL  COSTS  OF  PRODUCTION     167 

a  clear  vision  of  the  essential  realities.  At  a  time  when 
there  is  much  unemployment,  and  much  machinery 
standing  idle,  it  is  so  clear  to  common  sense  that  we 
could  produce  more  of  some  particular  thing  without 
diminishing  the  supply  of  other  things,  that  any  ap- 
parent statement  to  the  contrary  may  perhaps  seem 
the  height  of  academic  pedantry.  But  let  me  ask  the 
reader  to  consider  with  an  open  mind  a  familiar  parallel. 
During  the  recent  war  there  was  inevitably  much  waste 
and  muddle  in  the  utihzation  of  the  military  resources 
of  the  Allies.  Some  regiments  would  be  kept  inactive 
for  long  periods,  not  for  purposes  of  rest  or  training, 
but  owing  to  some  defect  of  organization.  In  the 
manufacture  of  munitions,  an  insufficient  appreciation 
of  the  principles  of  joint  demand  led  to  the  piling  up  of 
excessive  stores  of  certain  materials,  which  were  useless 
until  commensurate  supplies  of  the  complementary 
factors  could  be  obtained.  It  is  unnecessary  to  multiply 
examples.  The  waste  of  both  man-power  and  material 
was  immense.  But  the  allocation  of  these  resources 
between,  for  instance,  the  various  theaters  of  war  was 
none  the  less  a  very  real  problem,  which  gave  rise  to 
much  engrossing  controversy.  It  was  an  axiom  that 
the  more  resources  you  employed  in  Mesopotamia  or  in 
Palestine,  the  less  resources  remained  available  for 
France.  No  one  thought  of  maintaining  that,  as  long 
as  there  was  any  waste  of  these  resources,  so  long  as 
there  remained  any  men  to  be  "combed  out"  of  un- 
essential industries,  you  could  pour  troops  and  muni- 
tions into  Salonika  without  stopping  to  consider  the 
needs  of  other  theaters  of  war.  Such  a  notion  would 
have  been  clearly  imbecile,  for  the  suflScient  reason 


168  SUPPLY  AND  DEMAND 

that  the  sending  of  armies  to  Salonika  would  do  nothing 
in  itself  to  secure  (however  much  it  might  incidentally 
stimulate)  the  more  efficient  use  of  the  resources  which 
remained. 

Now  this  is  precisely  analogous  to  the  problem  of 
the  allocation  of  our  resources  for  the  purpose  of  peace. 
Notwithstanding  all  the  wastes  and  maladjustments 
of  the  economic  system,  the  use  of  resources  to  produce 
one  commodity  does  in  general  curtail  the  production 
of  others.  The  mere  launching  of  a  new  business  enter- 
prise does  no  more  than  the  sending  of  an  army  to 
Salonika,  to  eliminate  waste  in  the  remainder  of  the 
economic  organism.  Unemplo3anent,  broadly  speaking, 
is  a  function  not  of  the  magnitude  of  the  normal  demand 
for  labor  (which  affects  rather  the  wage-level),  but  of 
fluctuations  in  the  demand  for  labor;  fluctuations 
from  one  day  to  another  as  at  the  docks,  from  one 
season  to  another  as  in  the  building  trades,  above  all 
from  one  period  of  years  to  another  as  in  the  cycles  of 
general  trade  boom  and  depression.  Nothing  will 
diminish  imemplo5anent  which  does  not  serve  to 
diminish  these  fluctuations.  A  new  business  will  not, 
as  a  rule,  have  any  such  effect.  If  it  is  launched  dur- 
ing a  trade  depression  (a  most  unusual  proceeding), 
it  may  temporarily  absorb  unemployed  labor  and  idle 
materials.  But  when  the  next  boom  comes,  it  wilJ 
be  using,  though  presumably  to  greater  advantage, 
labor  and  materials  which,  but  for  it,  would  have 
been  employed  for  other  purposes.  Meanwhile  the 
causes  making  for  unemployment  will  be  unaffected. 
Miscalculations  will  still  be  made,  the  building  trades 
will  still  become  slack  in  the  winter,  the  casual  methods 


THE  REAL  COSTS  OF  PRODUCTION     169 

of  engaging  dock  laborers  will  still  continue,  trade  cycles 
will  still  recur,  while  beneath  them,  and  concealed  by 
them,  some  industries  will  expand  and  others  will  decay. 
Thus,  like  the  armies  at  Salonika,  the  new  business 
would  in  effect  divert  resources  from  elsewhere. 

This  truth  needs  to  be  firmly  grasped  in  mind.  It 
is  this  that  makes  it  in  general  unsound  policy  to  sub- 
sidize industries,  either  directly  or  indirectly,  by  means 
of  a  protective  tariff.  It  is  this,  indeed,  that  supplies 
the  answer  to  half  the  economic  fallacies  that  are  al- 
ways current. 

The  allocation  of  resources  so  as  to  yield  the  maxi- 
mum effect  was  rightly  recognized  as  one  of  the  most 
vital  and  difficult  of  our  war-time  problems.  To  cope 
with  it,  the  Allied  peoples  devised  one  instrument  after 
another,  and  finally  evolved  the  Supreme  Allied  Couq- 
cil.  The  analogous  problem  in  the  economic  world  of 
peace  time  is  no  less  important  and  far  more  difficult; 
but  there  is  nothing  to  correspond  to  the  Supreme  Al- 
lied Council.  There  we  rely  upon  a  co-operation  which, 
as  was  stressed  in  Chapter  I,  is  unco-ordinated.  That 
co-operation  has  been  evolved  by  the  mutual  com- 
petition of  innumerable  business  concerns,  controlled  by 
men  largely  animated  by  the  motive  of  pecuniary  profit. 
But  it  has  not  been  evolved  wholly  by  such  means: 
and  how  far  that  competition  or  that  motive  of  profit 
is  essential  to  its  efficiency  are  questions  with  which 
this  volume  has  not  been  in  any  way  concerned.  The 
economic  laws,  the  relations  between  utility,  and  price 
and  cost,  with  which  it  has  been  occupied,  are  an  en- 
tirely different  matter;  and  these  are  essential  to  the 
efficiency  of  any  system  of  society.    For  if  the  marginal 


170  SUPPLY  AND  DEMAND 

utility  of  a  commodity  is  equal  to  its  marginal  cost,  and 
if  this  marginal  cost  is  composed  of  payments  to  the 
various  agents  of  production  at  least  as  great  as  they 
could  have  obtained  if  they  had  been  used  otherwise, 
this  amounts  to  saying  that  the  agents  of  productioa 
are  so  utilized  as  to  yield  the  maximum  utility;  and 
this  is  the  same  thing  as  saying  that  they  are  so  utilized 
as  to  produce  the  maximum  wealth. 

§  3.  Utility  and  Wealth.  Upon  this  last  point  it  is 
important  to  be  quite  clear.  An  increase  in  wealth 
seems  a  solid,  tangible  reality;  something,  which, 
however  much  we  may  scorn  it  in  our  more  precious 
moods,  we  recognize,  for  a  rather  poor  community, 
to  be  an  important  object  of  endeavor.  But  an  in- 
crease in  utility  seems  a  vague,  impalpable  notion, 
hardly  deserving  the  same  practical  concern.  None  the 
less  the  two  things  are  identical.  We  greatly  deceive 
ourselves  if  we  suppose  wealth  to  be  an  objective  reality. 
It  is  true  that,  when  we  get  behind  the  money  in  which 
it  is  measured,  we  come  upon  commodities,  like  food 
and  clothes  and  houses  and  factories,  which  seem 
comfortably  solid  and  objective  things;  but  we  also 
come  upon  many  services,  like  those  of  gardeners  and 
doctors  and  hospital  nurses,  which  we  are  bound  to 
reckon  as  part  of  our  wealth,  although  they  are  not 
embodied  in  any  tangible  commodities.  Moreover, 
although  material  commodities  are  objective  realities 
in  themselves,  and  in  many  of  their  properties,  they  are 
not  objective  realities  in  their  property  as  wealth.  A 
pair  of  boots  is  an  objective  fact;  so  is  the  number  of 
pairs  in  existence  at  any  time,  so  is  their  size,  their 


1 


THE  REAL  COSTS  OF  PRODUCTION     171 

weight,  the  quantity  of  leather  or  of  paper  which  they 
happen  to  contain.  But  the  wealth  which  those  boots 
represent  is  not  an  objective  fact.  It  depends  upon  the 
opinion  which  men  and  women  entertain  as  to  their 
utility;  and  these  opinions  take  us  into  the  subjec- 
tive regions  of  human  psychology.  Let  us  suppose, 
for  instance,  that  we  calculated,  on  the  basis  of  present 
prices,  that  the  boots  in  existence  at  the  present  time 
represented  xtoo  P^^  of  our  total  wealth.  Suppose, 
then,  that  a  miracle  were  to  happen;  that  the  skies 
opened  and  rained  boots  upon  us,  of  every  size  and 
shape  and  pattern,  until  we  had  1000  times  as  many 
boots  as  we  had  before.  Could  we  say  that  our  total 
real  wealth  had  been  doubled?  Clearly  we  could 
not.  To  obtain  boots  for  nothing,  and  to  wear  a  new 
pair  every  week,  would  make  us  somewhat  better  off, 
but  not  twice  as  well  off  as  we  were  previously.  In 
other  words,  the  real  wealth  of  a  thousand  times  as 
many  boots  as  we  have  now,  is  not  a  thousand  times  as 
great  as  the  wealth  of  the  present  number  of  boots.  We 
are,  indeed,  practically  restating  the  Law  of  Diminish- 
ing Utility;  and  this  perhaps  is  enough  to  show  that 
wealth  is  fundamentally  the  same  thing  as  utility. 

Another  point,  however,  is  worth  noting.  Our  real 
wealth  would  be  somewhat  increased  in  the  case  sup- 
posed; but  if  we  were  to  turn  to  the  money  measure 
of  wealth,  the  opposite  result  would  be  far  more  likely. 
For  the  price  of  boots  would  most  likely  fall  to  nothing, 
and  the  total  value  of  boots,  in  the  commercial  sense, 
would  accordingly  be  nothing  also.  This  shows  that 
money  values  may  be  a  most  imperfect  measure  of 
aggregate  wealth;  for  what  money  values  represent  is 


172  SUPPLY  AND  DEMAND 

the  product  of  the  quantity  of  the  commodity  and  its 
marginal  utility,  while  aggregate  wealth  is  total  utility, 
which  is  a  very  different  thing.  This,  it  may  be  ob- 
served, makes  all  attempts  to  compare  the  wealth  of  dif- 
ferent countries  or  different  times,  and  no  less  to  con- 
struct Index  Numbers  of  Prices,  imperfect  of  necessity, 
and  arbitrary  in  their  foundations. 

§  4.  Criteria  of  Policy.  The  point  has  now  been  reached 
at  which  we  must  take  into  account  the  very  important 
fact  which  was  mentioned  at  the  close  of  Chapter  III. 
The  maximum  utility  which  the  laws  of  supply  and 
demand  tend  to  bring  about  is  a  maximum  total  utility 
indeed,  but  one  still  measured  in  terms  of  money.  An 
unequal  distribution  of  wealth  destroys  any  necessary- 
correspondence  between  that  and  the  maximum  real 
utility.  This  consideration,  however,  does  not  affect 
the  general  validity  of  the  conclusion  that  the  laws  of 
supply  and  demand  represent  what  is  socially  desirable 
now  or  under  any  system.  For  what  is  at  fault  here  is 
the  distribution  of  wealth;  and  it  is  that  which  should 
be  changed,  in  so  far  as  it  is  possible  to  do  so.  Now  it  is 
important  to  realize  that  whenever  it  is  possible  to 
supply  a  commodity  to  poor  people  below  cost  price, 
it  is  possible  to  alter  the  distribution  of  wealth,  for  that 
in  effect  is  what  is  done.  Purchasing  power,  which  may 
be  taken  from  richer  people  by  taxation,  or  which  may 
be  obtained  from  ''collective"  profits  on  other  trading, 
is  in  effect  transferred  to  the  poor  people  in  question, 
though  the  transference  is  coupled  with  the  condition 
that  the  purchasing  power  must  be  expended  in  a 
particular  way.     It  is  in  general  desirable  that  the 


THE  REAL  COSTS  OF  PRODUCTION     173 

transference  should  be  made  without  this  condition 
being  attached.  To  this  general  statement,  exceptions 
indeed  exist  so  numerous  and  important  as  possibly  to 
justify  a  great  extension  of  social  expenditure  of  this 
type.  Education  should  certainly  be  provided  free  of 
charge,  there  are  strong  arguments  for  subsidizing 
housing;  the  provision  of  milk  to  expectant  mothers, 
the  feeding  of  school  children,  such  instances  can  be 
multiplied  into  a  very  extensive  list.  But  it  is  impor- 
tant to  observe  thab  in  each  case  the  justification  of  the 
policy  rests  in  the  presumption  that  the  service  supplied 
is  one  which  it  is  particularly  important  that  the  bene- 
ficiaries should  have,  as  compared  with  the  other  things 
upon  which  they  might  have  preferred  to  expend  the 
equivalent  purchasing  power,  had  it  been  transferred 
to  them  without  conditions.  Where  there  is  no  such 
presumption,  as  surely  there  is  none  in  the  case  of  the 
great  bulk  of  commodities,  the  relation  between  price 
and  marginal  cost  should  be  rigidly  maintained;  it 
is  the  distribution  of  purchasing  power  which  we  should 
rather  seek  to  alter.  How  far  is  it  possible  to  alter  that? 
I  suppose  that  it  is  inevitable  that  many  readers  will 
have  concluded  that  the  preceding  chapters  must  be 
taken  to  mean  that  the  distribution  of  wealth  is  not 
susceptible  of  any  appreciable  change.  I  would  remind 
those  readers  of  an  important  distinction  upon  which 
unpatient  people  have  sometimes  based  a  complaint 
against  economists.  The  economist,  it  is  said,  analyses 
with  great  pomp  and  ceremony  the  laws  governing  the 
distribution  of  wealth  among  the  agents  of  production, 
but  says  practically  nothing  about  the  distribution 
between  individuals  and  classes,  which  is  the  only  thing 


174  SUPPLY  AND  DEMAND 

of  any  real  interest  to  practical  people.  Now  the  econ- 
omist concentrates  on  the  agents  of  production  for 
the  very  good  reason  that  it  is  only  with  respect  to  them 
that  any  clear  and  certain  laws  as  to  distribution  can 
be  laid  down.  Into  the  distribution  between  indi- 
viduals and  classes  there  enter  other  and  variable 
factors,  governed  by  no  fundamental  economic  law; 
and  here,  the  conclusion  should  at  once  suggest  itself, 
is  the  field  for  action  designed  to  alter  the  distribution 
of  wealth.  What  is  possible  or  desirable  in  this  field, 
it  is  again  not  the  purpose  of  this  volume  to  discuss. 
It  is  an  obvious,  even  if  not  a  very  helpful  conclusion 
that  an  increase  in  the  habit  of  saving  among  weekly 
wage-earners  might,  without  appreciably  affecting  the 
distribution  between  Capital  and  Labor,  greatly  mod- 
ify the  resulting  distribution  between  social  classes. 
But  questions  as  to  how  far  it  might  be  possible  or 
justifiable  to  achieve  a  similar  result  by  the  use  of  the 
weapon  of  taxation,  by  changes  in  inheritance  laws,  or 
by  the  public  ownership  of  industry  take  us  into  a  far 
more  uncertain  and  controversial  sphere.  The  diffi- 
culties and  objections  which  present  themselves  are 
familiar  and  formidable;  but  they  are  of  quite  a  dif- 
ferent order  from  the  economic  laws  which  we  have 
been  examining.  The  laws  themselves  do  not  entitle  us 
to  make  any  dogmatic  pronouncement  upon  these  large 
issues  of  social  policy. 

But  this  is  not  to  deprive  these  laws  of  practical 
importance.  They  represent  essential  criteria  of  sound 
policy  in  the  sphere  of  social  reorganization  no  less  than 
in  ordinary  business.  In  our  days  a  curious  obsession 
has  led  many  people  to  disparage  these  criteria,  as 


THE  REAL  COSTS  OF  PRODUCTION     175 

though  they  were  the  sordid  prejudices  of  a  stupid 
tradesman.  Because  it  has  been  found  a  matter  of 
obvious  practical  convenience  to  maintain  the  roads 
out  of  taxation  or  of  rates,  and  to  dispense  with  charges 
for  their  use,  it  is  suggested  that  the  same  principle 
should  be  applied  to  the  railways.  Or,  more  commonly, 
because  it  has  been  found  convenient  to  make  the  same 
charge  for  the  carrying  of  letters  between  Land's  End 
and  John  o'  Groats  as  between  Hampstead  and  High- 
gate,  it  is  suggested  that  this  principle  should  be  applied 
to  railway  rates  and  fares.  It  may  be  well,  therefore,  to 
point  out  that  the  justification  of  uniform  postal  charges 
rests  upon  the  facts:  (1)  that  the  costs  of  collection, 
sorting,  etc.,  are  so  large  a  part  of  the  costs  of  carry- 
ing a  letter,  that  the  real  cost  between  John  o'  Groats 
and  Land's  End  does  not  differ  from  that  between 
Hampstead  and  Highgate  by  as  much  as  might  at 
first  sight  appear,  (2)  that  the  charges  in  any  case  are 
very  small;  so  that  (3)  the  avoidance  of  the  small  de- 
gree of  taxes  and  bounties  which  the  present  system 
implies  is  not  worth  the  book-keeping  expenses  which 
differential  charges  would  involve.  It  should  be  ob- 
vious that  these  considerations  apply  to  the  railways 
with  a  greatly  diminished  force.  They  might  possibly 
justify  what  is  loiown  as  the  "zone"  system  of  charges, 
i.  e.  uniform  rates  within  certain  narrow  areas.  But  the 
notion  of  uniform  rates  throughout  Great  Britain 
conjures  up  a  vision  of  trains  taking  coal  from  South 
Wales  to  Scotland,  and  others  taking  coal  from  Scot- 
land to  South  Wales,  in  accordance  with  the  slightest 
preferences  of  the  consumers,  and  without  regard  to  the 
extra  real  cost  involved,  on  a  scale  to  which  the  "wastes 


176  SUPPLY  AND  DEMAND 

of  competition"  afford  no  parallel.  It  would  in  fact 
achieve  the  essential  folly  of  "sending  coals  to  New- 
castle." These  considerations,  however,  are  not  what 
interest  the  advocates  of  the  postal  principle.  They  seem 
to  recommend  the  obliteration  or  the  confusion  of  the  re- 
lations between  price  and  cost  as  a  superior  ideal.  It  is 
important  to  be  clear  what  exactly  this  ideal  involves. 

It  involves,  in  the  first  place,  as  the  whole  argument 
of  this  volume  has  gone  to  show,  a  less  economical 
employment  of  our  productive  resources;  they  would 
be  diverted  to  ends  of  less  utility,  and  so  produce  less 
real  wealth.  But  this  is  not  the  worst.  There  is  plenty 
of  waste  and  maladjustment  in  our  economic  system  at 
the  present  time.  The  desirable  relation  of  price  to 
marginal  cost  is  but  imperfectly  attained.  The  further 
departures  from  this  relation,  which  would  follow  from 
any  likely  applications  of  the  postal  principle,  might  not 
matter  in  themselves  so  very  much.  What  is  far  more 
serious  is  that  the  criteria  of  efficiency  would  become 
blunted,  and  the  clear  aims  of  management  would  be 
confused  in  fog.  It  is  essential  that  every  manager 
should  be  on  the  alert  to  eliminate  waste  and  to  improve 
efficiency,  that  he  should  be  always  trying  to  secure 
the  best  results;  but  how  can  he  do  this  if  he  has  no 
simple  means  of  measuring  what  results  are  good  and 
what  are  bad?  The  measure  which  he  has  at  present 
is  that  of  price,  cost  and  the  resultant  profit,  and  it 
would  be  fatal  to  take  that  away,  unless  an  equally 
simple  and  more  accurate  measure  could  be  substituted 
for  it. 

This  is  not  a  question,  it  should  be  observed,  of 
motive  or  incentive.    Very  likely  we  much  exaggerate 


THE  REAL  COSTS  OF  PRODUCTION     177 

the  importance  of  the  profit  motive.  It  may  be  true 
that  men  would  work,  perhaps  that  they  already  work 
in  fact,  as  zealously  for  a  fixed  salary,  as  for  personal 
gain.  But  aim  and  motive  are  two  somewhat  different 
things,  and  the  aim  of  profit,  is,  and  will  remain,  essential 
to  the  efficient  conduct  of  business.  In  a  game  the 
players  are  not  animated  by  the  motive  of  scoring  runs 
or  points,  but  they  aim  at  them;  and  the  zest  disap- 
pears very  speedily  from  the  game,  if  that  aim  ceases 
to  be  of  interest.  Moreover,  while  a  scoring  system  is 
always  a  somewhat  arbitrary  thing,  measuring  im- 
perfectly the  true  merits  of  the  play,  if  it  measures 
them  with  the  roughest  accuracy,  we  prefer  the  issue 
of  our  games  to  be  decided  so,  rather  than  by  the  de- 
cisions of  an  impartial  judge,  who  can  take  into  ac- 
count the  finest  points  of  skill.  So  it  is  in  the  world 
of  business.  The  scoring-board  of  profits  may  be  an 
imperfect  one;  let  us,  by  all  means,  where  we  can,  al- 
ter the  rules  of  the  game  so  as  to  make  it  better.  But 
let  us  not  imagine  that  it  displays  a  finer  insight  or  a 
superior  intellect  to  speak  as  though  the  scoring-board 
could  be  dispensed  with,  and  the  test  of  profit  and  loss 
treated  as  irrelevant.  Quantitative  measurement  is 
essential  to  efficiency.  Let  us  be  careful  to  remember 
all  that  this  implies. 


INDEX 


Abaity,  152 
Accountancy,  58 
Allocation  of  resources,  166 
Ambiguities,  24 
Australasia,  66 

Bastiat,  Frederic,  5 

Beef  and  hides,  7 

Borrowing  and  lending,  system 

of,  12 
Business  efficiency,  58 
Business  man  as  a  purchaser,  47 
Business  risk,  104 

Capital,  119;  as  representing  a 
period  of  waiting,  123;  dis- 
tribution, 131;  distribution 
and  rate  of  interest,  137;  ef- 
fect on  labor  of  an  increased 
supply,  77;  not  a  stock  of 
consumable  goods,  123;  re- 
action of  price  charges  on,  31; 
reflections  upon,  11;  supply, 
130;  supply  as  affected  by 
charges  in  interest  rate,  132 

Capital  goods,  61 

Capital  market,  13 

Capitalism,  17 

Capitalist,  116 

Chance,  105 

Coal  industry,  cost  of  produc- 
tion and  price,  52;  miners' 
wages,  75 

Coats,  J.  &  P.,  75,  155 

Collective  saving,  129 

Commodities,  7,  19;  labor  as  a 
commodity,  19 

Competition,  140 

Composite  demand,  80 

Composite  supply,  80 

Consumable  goods,  123 


Consumers'  goods  and  pro- 
ducers' goods,  49 

Consumption,  margin  of,  37; 
waiting  for,  121 

Control  and  risk-taking,  116 

Controversy,  1,  6 

Cooperation,  3;  unorganized, 
5,7 

Cost,  general  relation  of  price, 
utility  and  cost,  65;  price 
relation  to,  37,  39,  52;  rent 
as  factor  in  real  costs,  100; 
ultimate,  82,  162;  utility  and, 
165 

Cotton  and  cotton-seed,  7; 
contrast  to  wool  and  mutton, 
71 

Cotton  industry,  154 

Criteria  of  policy,  172 

Currency  inflation,  33 

Cycles,  34,  125 

Demand,  ambiguity  of  expres- 
sion "increase  in  demand," 
24;  derived,  82;  elastic  and 
inelastic,  76;  see  also  Com- 
posite demand;  Joint  de- 
mand;  Supply  and  demand 

Derived  demand,  82 

Derived  utility,  49 

Diagrams,  use  of,  21 

Diminishing  utility,  40;  money 
and,  49 

Directors,  135 

Distribution  of  wealth,  131, 
172;  interest  rate  and,  137 

Dividends,  135 

Division  of  labor,  3 

Economic  laws,  140,  142;  fun- 
damental character,  17 


178 


INDEX 


179 


Economic  theory,  v,  143;  fact 
and,  1 

Economic  world,  orderly  na- 
ture, 1 

Education,  150,  160 

Efficiency,  58,  177 

Elastic  demand,  76 

Employers'  associations,  156 

Enterprise,  104,  109 

Entrepreneur,  113 

"Equal  pay  for  equal  work," 
158 

Expectation,  106 

Fact  and  theory,  1 
Farmers,  90 
Fortunes,  116 

Gambling,  106 

Government,  enterprises,  114; 
failings,  139 

Hides  and  beef,  7 

Houses,  103 

Housewife  as  purchaser,  41,  43, 

44,  47 
Housing,  64,  129 
Ideas  and  institutions,  141 
Incompetents,  59 

Increase  in  demand,  ambiguity, 
24 

Index  numbers,  172 

Inelastic  demand,  76 

Inflation,  63 

Institutions  and  ideas,  141 

Insurance  companies,  107,  111; 
significance,  108 

Interest,  119;  necessity  of,  129 

Interest  rate,  14;  changes  and 
their  effect  on  supply  of 
capital,  132;  distribution  and, 
137;  price  of  land  and,  102 

Intuition,  114 

Joint  demand,  66;  importance 
of  the  unimportant,  74;  mar- 
ginal utility  under,  69;  sum- 
mary of  considerations,  79 


Joint  products,  7;  cost  of  pro- 
duction, 40 
Joint-stock  company,  135 
Joint    supply,    marginal    cost 
under,  66;  summary  of  con- 
siderations, 79 

Keynes,  J.  M.,  vi 

Labor,  139;  apportionment 
among  occupations,  153;  ap- 
portionment among  places, 
147;  apportionment  among 
social  grades,  149;  as  a  com- 
modity, 19;  cost,  difficulty  of 
estimating,  163;  division,  3; 
effect  of  increased  supply  of 
capital,  77;  four  grades,  149; 
mobility,  148;  product  of, 
119;  reaction  of  price  changes 
on,  31;  supply  in  general, 
145 
Laissez-faire,  11;  retrospect  on, 

139 
Land,  characteristics,  83;  dif- 
ferential aspect,  87;  margin 
of  transference,  94,  96;  mar- 
ginal, 88;  price  and  rent,  re- 
lation, 102;  question  of  real 
costs,    100;   scarcity  aspect, 
84;  supply,  30;  tenure,  92; 
urban,  94;  see  also  Rent 
Landlords,  91,  92 
Large  scale  business,  58 
Laws,  fundamental,  18,  29 

Malthus,  T.  R.,  146 
Management,  104 
Margin,  danger  of  ignoring,  57 
Margin  of  consumption,  37 
Margin  of  production,  52 
Margin  of  transference,  94,  96 
Marginal  cost,  aspects,  55;  mis- 
interpretation,     59;     under 
joint  supply,  66 
Marginal  land,  88 
Marginal  purchaser  44 


180 


INDEX 


Marginal  utility,  42;  price  re- 
lation to,  43;  under  joint  de- 
mand, 69 

Market,  13 

Marshall,  Alfred,  vi 

Marx,  Karl,  119 

Mill,  J.  S.,  86 

Miners,  75 

Monetary  changes,  disturb- 
ances of,  33 

Money,  diminishing  utility,  49 

Monte  Carlo,  106 

Mutton.   See  Wool  and  Mutton 

Natural  ability,  152 
Normal  conditions,  36 

Occupations,    160;    apportion- 
ment of  labor  among,  153 
Order,  economic,  5 

Pasture  versus  tillage,  97 

Pigou,  A.  C,  vi 

Policy,  criteria,  172 

Population,  85,  146 

Postal  charges,  175 

Poverty,  131;  national,  128, 
129 

Price,  consequences  of  higher, 
60;  general  relation  with 
utility  and  cost,  65;  law  of 
tendency,  19;  marginal  util- 
ity and,  43;  post-war,  61;  re- 
action of  changes  in  demand 
and  supply,  27;  relation  of 
demand  and  supply  to,  20; 
utUity  and,  40 

Producers'  goods,  49 

Production,  power  of,  125;  real 
costs,  162;  waiting  for,  120 

Professions,  150 

Profiteering,  75 

Profits,  61,  177;  elements,  104; 
general  analysis,  117;  in 
risky  industries,  110,  115 

Protective  tariff,  169 

Psychology  and  economics,  1 


Purchasers,  business  man,  47; 

housewife,    41,    43,    44,    47; 

marginal,  44 
Purchasing  power,  33,  61,  172 

Railway  rates,  175 

Railways,  64 

Rate  of  interest.  See  Interest 
rate 

Rent,  82,  83;  complex  char- 
acter, 90;  marginal  land,  89; 
necessity,  98;  rate  of  interest 
and, 102 

Reserves,  136 

Residuary  profits,  110 

Resources,  allocation,  166 

Risk,  reward  for,  104;  under 
large-scale  organization,  111 

Satisfaction,  50 

Saving,  127,  174;  individual, 
127;  involuntary^  134;  psy- 
chology, 133;  social,  128 

School  teachers,  160 

Service,  19 

Serving  cotton,  74 

Shareholders,  135 

Sinking-fund,  134 

Situation,  88 

Smith,  Adam,  v,  139 

Social  grades,  labor  movement 
among,  149 

Socialism,  9, 11, 14,  59, 134, 141 

Speculation,  112-113 

Steel  smelters,  76 

Subsidies,  industrial,  169 

Substitutes,  SO 

Supply,  reactions  of  pric^> 
changes  on,  30;  see  also  Com- 
posite supply;  Joint  supply 

Supply  and  demand,  changes 
in,  and  their  reaction  on 
price,  27;  forces  behind,  37; 
general  laws,  18,  29;  relation 
of  price  to,  20;  wages  and, 
143 

Supreme  Allied  Council,  169 


INDEX 


181 


Teachers,  160 
Theory,  economic,  v,  1 
Thrift,  127 

Tillage  versus  pasture,  97 
Trade  cycles,  34,  125 
Trade  depression,  33 
Trade  unions,  144;  actions,  154; 
wage  level  and,  156 


Ultimate  real  costs,  82,  162 
Unearned  increment,  86 
Unemployment,      168;      trade 

union  policy  and,  144 
Utility,  37;  cost  and,  165;  de- 
rived, 49;  general  relation  of 
price,  utility  and  cost,  65; 
law  of  diminishing  utility, 
40;  law  of  diminishing  utility 
as   applied    to    money,    49; 


marginal,  42;  price  relation 
to,  38,  40;  wealth  and,  170 

Wages,  general  wage  level,  143; 
trade  unions  and,  155,  156; 
women's,  157 

Wages  Fund,  125 

Waiting,  essence  of,  126;  for 
consumption,  121;  for  pro- 
duction, 120 

Waste,  economic,  167,  168,  176 

Wealth,  distribution,  131,  137, 
172;  utility  and,  170 

"What  should  be"  and  "What 
is,"  141 

Women's  wages,  157 

Wool  and  mutton,  7,  66;  con- 
trast to  cotton  and  cotton- 
seed, 71 

Workers'  control,  117 


CAMBRIDGE  ECONOMIC  HANDBOOKS 

General  Editor:  J.  M.  Keynes,  Fellow  oj  King's 
College,  Cambridge.  Author  oj  "Economic  Con- 
sequences of  Peace,"  etc. 

Assistant  Editor:  H.  D.  Henderson,  Fellow  of 
Clare  College,  Cambridge. 

SUPPLY  AND  DEMAND 

By  H.  D.  Henderson,  M.A.,  Fellow  of 
Clare  College,  Cambridge;  University  Lec- 
turer in  Economics. 

MONEY 

By  D.  H.  Robertson,  M.A.,  Fellow  and 
Lecturer   of  Trinity   College,   Cambridge. 

PUBLIC  FINANCE 

By  M.  E.  Robinson,  Lecturer  in  Economics 
at  Manchester  University;  Director  of 
Studies  in  Economics  at  Newnham  College, 
Cambridge. 

THE  DISTRIBUTION  OF  WEALTH 

By   G.   F.   Shove,   M.A.,  King's  College, 

Cambridge. 

THE  CONTROL  OF  INDUSTRY 

By  D.  H.  Robertson,  M.A.,  Fellow  and 
Lecturer   of  Trinity   College,   Cambridge. 

POPULATION 

By  Harold  Wright,  M.A.,  Pembroke  Col- 
lege, Cambridge;  Member  of  the  Advisory 
Committee  on  Fishery  Research. 


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